UK economy unexpectedly contracted 0.1% in January

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The UK economy unexpectedly contracted by 0.1 per cent in January, underscoring the challenge facing chancellor Rachel Reeves as she prepares to deliver a high-stakes Spring Statement this month.

Friday’s monthly GDP figure from the Office for National Statistics was below both the 0.1 per cent growth predicted by economists polled by Reuters and December’s 0.4 per cent. The decline was largely driven by weakness in the production sector.

Reeves is preparing to rein in public spending in her March 26 Spring Statement after disappointing growth and government borrowing figures sparked fears that she is on track to break her fiscal rules.

Growth has largely stalled since May, hitting tax revenues, after the UK economy rebounded from a technical recession at the start of 2024.

The Office for Budget Responsibility in October forecast economic growth for 2025 at 2 per cent — double the 1 per cent predicted by economists polled by Reuters. The watchdog is expected to release a new forecast alongside the Spring Statement.

Suren Thiru, economics director at the Institute of Chartered Accountants, said January’s GDP contraction made Reeves’ Spring Statement “more problematic” since it increased the likelihood that the OBR would downgrade its forecasts, “further undermining the chancellor’s spending plans”.

The pound weakened slightly after Friday’s data release, down 0.2 per cent against the dollar at $1.292. Gilts were steady in early trading, with the 10-year yield flat at 4.68 per cent.

The figures come as the fallout from Donald Trump’s escalating trade war has added to the economic strains facing the UK, as well as the prospect of higher defence spending as the US president disrupts western security alliances.

“The world has changed and across the globe we are feeling the consequences,” Reeves said in response to Friday’s figures.

As a result, she said, “we are launching the biggest sustained increase in defence spending since the cold war, fundamentally reshaping the British state to deliver for working people and their families, and taking on the blockers to get Britain building again”.

The Labour party won the general election last July with a promise to kick-start growth, but Reeves has faced criticism over her October Budget, which left businesses bearing the brunt of £40bn in tax increases.

Businesses have warned of job cuts as a result of the measures, which take effect from April.

Paul Dales, economist at the consultancy Capital Economics, said January’s fall in output “highlights the weakness of the economy before the full effects of the rise in business taxes and the uncertain global backdrop is felt”.

The Bank of England is expected to keep rates on hold at 4.5 per cent at its meeting next week amid signs of a rebound in inflation. Last month, the central bank cut its economic growth forecast for the first quarter of 2025 to 0.1 per cent, from the 0.4 per cent expected in November.

Despite January’s contraction, Thiru said a rate cut by the BoE next week was “unlikely” as rate-setters would probably want to assess the impact of the increase in employers’ national insurance contributions from the Budget.

Friday’s data cemented traders’ expectations that there will be at least two further quarter-point interest rate cuts from the BoE this year, with the slim chance of a third, according to levels implied by swaps markets.

According to Friday’s ONS data, the manufacturing sector contracted 1.1 per cent in January, with a 0.2 per cent decline in construction, while services grew 0.1 per cent.

Liz McKeown, ONS director of economic statistics, said the overall picture for the UK economy was of “weak growth”. 

However, services continued to grow in January, she said, “led by a strong month for retail, especially food stores, as people ate and drank at home more”. 

The ONS said the publication of trade data, usually released alongside GDP figures, had been delayed due to errors.