UK GDP: What now for interest rates as shock contraction sparks recession fears?

Official figures show that gross domestic product (GDP) - a measure of overall economic output - contracted 0.1 per cent during January, behind the 0.1 per cent expansion predicted by economists and down from a 0.4 per cent rise in GDP in December. The latest statistics come less than two weeks before Chancellor Rachel Reeves delivers her spring statement, amid speculation of growth downgrades and fresh spending cuts.

The Office for National Statistics (ONS) said January’s surprise contraction came from a weak performance in the manufacturing and construction sectors, partly dampened by poor weather. Meanwhile, the escalating global trade war started by US President Donald Trump has sparked concerns about future growth.

Last month, it emerged that the better-than-expected expansion of 0.4 per cent in December had pushed GDP up by 0.1 per cent between October and December, following no growth in the previous three-month period. For there to be a technical recession there would have to be two or more quarters in a row of falling output.

Many analysts point to a worrying outlook amid April’s hike in employer national insurance contributions and the minimum wage, alongside rising energy, water and council tax bills. There are also fears of a US recession in the first half of 2025, as the global trade war intensifies.

Labour has made growing the economy its key priority since winning the election last year but momentum has been slow amid falling consumer confidence and stubbornly sticky inflation.

Nicholas Hyett, investment manager at Wealth Club, said it was possible that the “recession starts here”, with the economy shrinking when it had been expected to show modest growth.

“The slowdown has been driven by a big slowdown in manufacturing output - unsurprising given the very uncertain outlook for exports with ever changing tariffs,” he noted. “Services too has slowed dramatically, particularly in sectors like accommodation and food services which expect to be hit hard by higher living wage and employer national insurance contributions in April.

“Those worries will soon be transforming into realities. That leaves plenty of room for economic growth to deteriorate further. With far fewer catalysts to spark an economic recovery, we could be at the start of a long slow slide into recession.”

The Bank of England (BoE) is likely to keep interest rates at 4.5 per cent next week when policymakers meet to decide on their next course of action. However, that cautious approach to easing could change if the economy deteriorates further.

ING Developed Markets economist James Smith noted: “The major question mark, both for the BoE and the growth outlook generally, is what impact the big tax hike on employers next month will have on the jobs market, which has already cooled significantly over recent months. A spike in layoffs, which so far hasn’t happened, could be a game changer for the 2025 growth outlook and for monetary policy.

“For now, we expect the bank to continue its quarterly pace of cuts, with moves in May, August and November this year.”

However, Rob Morgan, chief investment analyst at Charles Stanley, thinks a further rate cut is imminent.

“The economic environment is still fragile, and with today’s data the Bank of England won’t be having any regrets about last month’s decision to cut interest rates,” he said. “It’s greater focus on the growing risks to growth is very much warranted, and a further cut to interest rates could be on the cards later this month.”

Scottish Friendly savings specialist Kevin Brown added: “These are not the figures the Chancellor would have wanted ahead of a raft of tough spending decisions. Growth would have given her some reprieve, but the UK economy continues to flounder - remaining flat and quite vulnerable.

“Significant challenges remain and the knock-on effect for UK households remains uncertain. But wherever possible, if families are able to save and invest what they can, they will be able to provide their own certainty of greater financial resilience for the future.”

The Chancellor is due to deliver her spring statement on March 26.

GDP latest: Why UK’s surprise growth is no cause for celebration as living standards slide