Outlook for the UK economy and fiscal challenges

Hermione Taylor, the FT Investor’s Chronicle Economist, shared her outlook for the UK economy at the Elston Investment Forum

What is the outlook for the UK economy? How will the Chancellor balance between taxing, borrowing and spending?

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The UK Economic Outlook: Hermione Taylor’s candid assessment

​At the recent Elston Consulting investor day, award-winning financial journalist Hermione Taylor began her appraisal of the UK economy with a surprising statistic: GDP grew by 0.7% in the first quarter, stronger-than-expected performance. However, she went on to caution that this growth was likely front-loaded and may not be sustained throughout the year. Over the past 12 months, the UK’s growth rate of 1.1% matches France, lags behind the US, but outpaces Japan—offering a mixed picture of relative performance.

Inflation and interest rates: a balancing act

​Inflation remains a thorny issue for policymakers. The latest figure of 3.4% is well above the Bank of England’s 2% target, complicating decision-making. Taylor anticipates that the Monetary Policy Committee will likely hold rates steady, because there are internal disagreements about whether the current inflation spike is transitory or more persistent.

The Chancellor’s tightrope

For Chancellor Rachel Reeves, the overall health of the economy is of critical importance. With the autumn budget approaching, she needs some positive data points to demonstrate that her economic plan is working. Taylor explained the two fiscal rules that Reeves has committed to as chancellor – the rods for her back, as it were. First the “stability rule,” which requires day-to-day spending to be covered by revenues by 2029–2030, and second the “investment rule,” which mandates that debt must be falling as a share of GDP by the same date.
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These rules are forward-looking, meaning current economic performance is less important than whether the government is on track to meet its targets by the end of the forecast period. The Office for Budget Responsibility (OBR) plays a pivotal role in this, as its forecasts determine whether or not the chancellor is adhering to her rules.

Forecast revisions and fiscal headaches

Taylor highlighted how the OBR’s forecasts have shifted. Initially, the government expected 2% GDP growth this year, but that has been revised down to just under 1%. Inflation expectations have also risen—from 2.5% to 3.2%—and interest rates are now projected to be 0.5 percentage points higher than previously thought.

These changes have serious implications. Lower growth means lower tax revenues and a higher debt-to-GDP ratio. Higher inflation and interest rates increase the cost of servicing debt, particularly index-linked gilts, which make up a significant portion of the UK’s debt portfolio.

The cumulative effect of this has been dramatic. Reeves’ £9.9bn of headroom has turned into a £4.1 billion deficit. Taylor noted that this forced the chancellor to scramble to formulate policy changes in the spring statement in order to be seen to be maintaining fiscal discipline.
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In a historical context, Reeves’ fiscal headroom is slim. Even small changes in assumptions—such as a 0.6% rise in interest rates or a 0.1% drop in growth—could eliminate it entirely. This fragility makes the government’s fiscal position vulnerable to economic shocks.

Spending review: more smoke than fire

Taylor addressed recent headlines concerning the government’s spending review, which touted £190 billion more for public services and £113 billion in additional capital spending. She clarified that these figures are not new commitments but in fact a reallocation of previously announced funds.
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Economists remain concerned, though, because the review relies on optimistic assumptions regarding efficiency savings and includes front-loaded departmental budgets that will face cuts later in Parliament. Departments like education may struggle to maintain services under these constraints.

The Debt interest burden

One of Taylor’s most sobering points is the rising cost of debt interest. The UK spent £105bn on debt interest last year—more than on education or defence. This is a recent development, driven by higher inflation and interest rates, and is expected to rise to £120 billion by 2029–30.
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The trend is particularly troubling because it limits fiscal flexibility. With the tax burden already at a historic high—expected to reach 37.5% of GDP—there is little room to raise taxes further. Yet, without new revenue or faster growth, the government may struggle to achieve the two fiscal targets it has set for itself.

Growth: the elusive solution

​Taylor acknowledged that boosting growth would be the ideal solution. Higher growth would increase tax revenues and reduce the debt-to-GDP ratio. However, she is sceptical as to whether this can be achieved. The OBR assumes 1% annual productivity growth, but recent trends suggest a more realistic figure might be closer to 0.3%. A downgrade to even 0.75% would wipe out £20bn in headroom.

External risks and market sensitivity

The UK’s reliance on foreign investors for gilt purchases adds another layer of risk. Nearly a third of gilts are held overseas, making the UK vulnerable to shifts in global sentiment. Taylor recalls a period over Christmas when UK yields spiked due to US market movements, drawing unflattering comparisons to the Liz Truss era.
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The Bank of England is watching closely. Rising US yields cause UK financial conditions to tighten, potentially forcing the Bank to lower rates or adjust its quantitative tightening strategy. For the chancellor, even a modest rise in gilt yields could erase her fiscal headroom.

Conclusion: a precarious path ahead

​Taylor concluded that given the narrow fiscal margins and high economic uncertainty, further tax increases or spending cuts are likely in the autumn budget. While the government hopes for growth, the risks are skewed to the downside. Without a significant improvement in productivity or a shift in global conditions, the UK’s economic outlook remains fragile.