UK economy shrinks unexpectedly in blow to Rachel Reeves

The UK economy contracted by 0.1% in January, dealing a blow to Rachel Reeves before the spring statement later this month.

In a surprise to City economists, who had expected 0.1% growth in January, the Office for National Statistics data showed the services sector failed to offset a decline in the industrial sector and maintain growth from the previous month.

Manufacturing output fell by 1.1% in January 2025, reversing a spurt of 0.7% in December last year. Construction was another drag on the economy after poor winter weather held back housebuilders.

Services increased by only 0.1%, with falls in hospitality and arts and entertainment making the biggest dent in growth.

The ONS said gross domestic product (GDP) was estimated to have grown by 0.2% in the three months to January 2025, compared with the three months to October 2024, as a result of the growth in the services sector.

In December the economy expanded by 0.4%, helping the last quarter of the year to register a 0.1% rise and avoid two quarters of zero growth.

Yael Selfin, the chief economist at KPMG UK, said: “The UK economy starts the year on the back foot as global uncertainty casts a shadow on the outlook.”

Reeves blamed global economic uncertainty for the downturn, adding that a plan to increase defence spending would give the economy a lift.

She said: “The world has changed and across the globe we are feeling the consequences. That’s why we are going further and faster to protect our country, reform our public services and kickstart economic growth to deliver on our plan for change.

“And why we are launching the biggest sustained increase in defence spending since the cold war.”

Most business surveys have indicated that companies are putting a freeze on hiring workers and delaying investments to conserve funds. Business lobby groups have cited the upcoming steep rise in employer national insurance payments and an inflation-busting rise in the minimum wage in April for a fall in boardroom confidence levels.

Government spending projects have faced delays while ministers review plans put forward under the previous Conservative government. The chancellor is expected to announce deep cuts in government welfare spending in the spring statement on 26 March to stay within the government’s budget rules.

The shadow chancellor, Mel Stride, said: “It is no surprise that growth is down again, following near no growth in the last three months of 2024.”

Stride said the budget last October had hit businesses’ confidence. “After consistently talking Britain down, raising taxes to record highs and crushing business with their extreme employment legislation, this government is a growth killer,” he said.

Matt Swannell, the chief economic adviser to the EY Item Club, said monthly figures could be volatile. He said he had expected a dip in January and still expected growth to return in the coming months.

“Monthly GDP data can be noisy, and it was always likely that there would be some payback in January from December’s strong reading,” he said.

“The launchpad from a strong expansion at the end of last year means we expect quarterly GDP growth to be around 0.3% in the first quarter, a step up on the pace seen in the second half of 2024.”

Sterling, which has risen strongly over the past month as investors sold the dollar, edged down by 0.19% to $1.2921, but remained slightly higher against the US currency over the week.

The probability of an interest rate cut at the Bank of England’s meeting next Thursday rose very slightly on Friday, but is still seen as very unlikely, with financial markets estimating the chance of a cut at just over 8%, compared with just below 7% on Thursday. Rates are expected to be kept on hold at 4.5% next week before a quarter-point cut in May.

The National Institute of Economic and Social Research (Niesr) downgraded its forecast for growth the first quarter of 2025 from 0.4% to 0.3%, but kept its estimate much higher than the Bank’s, which has predicted growth will be limited to only 0.1%.

Many economists said that after the lacklustre performance in the second half of 2024, growth remains fragile because of global and domestic uncertainty.

Hailey Low, an economist at Niesr, said: “It is crucial that the upcoming spring statement provides stability rather than adding to domestic uncertainty. Frequent policy U-turns risk undermining business and investor confidence at a time when clarity and consistency are most needed.”