U.K. Economy Unexpectedly Contracts, Posing New Challenge to Government

The U.K. economy unexpectedly shrank in the first month of the year, the latest frustration for a relatively new government that has pledged to bring an end to a decade-and-a-half of stagnation.

Gross domestic product was 0.1% lower in January than in the final month of 2024, the Office for National Statistics said Friday, weaker than the 0.1% rise expected by a consensus of economists. It also marks a slowdown from the 0.4% recorded in December.

Despite the economy’s continued struggles, the Bank of England is expected to leave its key interest rate unchanged when it meets next week. The annual rate of inflation jumped to 3% in January and is set to rise further over coming months.

Weaker-than-expected growth means tax revenues are likely to be lower than the government anticipated, adding to the challenges facing Treasury Chief Rachel Reeves as she prepares to announce new budget plans later this month.

“The U.K. economy is stuck in the slow lane,” Scott Gardner, investment strategist at digital wealth manager Nutmeg, said. “This latest data just goes to show the mountain to climb for Chancellor [Reeves] to reclaim momentum and get Britain growing at pace in 2025.”

There appears to be little hope of respite soon. U.K. firms’ activity expectations for this year declined in February, in contrast with a mild improvement globally, according to an S&P survey published this week.

Private-sector businesses are set to shrink their workforces as profit outlooks darken, with S&P’s index of employment expectations turning negative for the first time in more than 15 years outside the pandemic lockdowns of mid-2020.

“It is also the only time aside from the pandemic where firms have forecast simultaneous cuts to employment, capital expenditure and research and development, demonstrating the gloomy outlook for U.K. business investment in 2025,” David Owen , senior economist at S&P Global Market Intelligence, said.

The BOE last month halved its forecast for economic growth in 2025 to 0.75%. However, since it currently expects 0.1% growth for the first quarter, the January data suggests the U.K. might have an even weaker start to the year.

The government’s fiscal watchdog is also set to cut its own forecasts later this month. Britain’s economy grew 0.9% in 2024 as a whole, compared to 2.8% in the U.S.

Adding uncertainty to the forecasts are new tariffs that the Trump administration could impose on both the U.K. and neighboring European Union, a move that would curtail growth further.

“The U.K.’s economic performance may have been similarly downbeat in February, with any boost from consumer spending amid strong wage growth and lower interest rates weakened by the brake on business activity from this torrent of global uncertainty,” Suren Thiru , economics director at the Institute of Chartered Accountants in England and Wales, said.

The economy was dragged in January by a 1.1% drop in manufacturing output, a sector that could bear the brunt of any trade barriers.

President Trump has already imposed 25% tariffs on all steel and aluminum imports, including those from the U.K. Exports of steel from the U.K. to the U.S. in 2024 was worth around 370 billion pounds, or around $480 billion, according to trade association U.K. Steel.

Prime Minister Keir Starmer on Wednesday said that the U.K. will “keep all options on the table” in response to the tariffs.

The stock market had a decent summer. Investors are bracing for a bumpier fall.

In the past couple of months, equity investors cheered soaring profits at big companies, shrugged off jitters in the bond market and nudged megacap tech shares back near records.

Now, as the post-Labor Day stretch begins, a number of new challenges lie ahead: ever-shifting odds of an interest-rate increase from the Federal Reserve. Sky-high expectations after a stunning earnings season. The persistent threat of higher consumer prices as fighting in the Middle East drags on.

“You’re moving from this earnings-driven market to this macro-driven market with the Fed, inflation and interest rates in focus,” said Keith Lerner, chief investment adviser for Truist Advisory Services. “It tends to be a choppier period.”

Historically, every major U.S. stock index experiences its worst average return in September. The Dow Jones Industrial Average has slid an average 1.1% in the ninth month of the year, in data that dates back to the 19th century. The S&P 500 has seen the same average decline—and for every September dating back to 1928, the benchmark ends the month lower more than half of the time.

Analysts caution against reading too much into those seasonal patterns. But in recent weeks, new reasons for investor caution have emerged. One of the largest: the looming threat of an interest-rate increase from the Fed, which announces its next policy decision on Sept. 16.

Chairman Kevin Warsh’s decision to ditch forward guidance and take more of his cues from markets has muddied the waters for investors when it comes to monetary policy. That has left traders scouring Fed governor speeches and economic-data reports for clues on the central bank’s next move.

“There’s going to be a lot of eyes on those numbers,” said John Luke Tyner, head of fixed income and portfolio manager at Aptus Capital Advisors.

The past couple of weeks offered just one example of how frequently those expectations can change. After Warsh struck a hawkish tone during remarks on Aug. 28, the odds of a hike at the Fed’s next meeting jumped from 35% before the speech to 58%, according to CME FedWatch data.

On Thursday, Fed governor Christopher Waller made a case for leaving rates where they are. Interest-rate futures showed coin-flip odds between a hike and a hold. Then Friday’s robust jobs report amped up rate-hike bets once more, back to a roughly 60% chance of higher rates after the meeting.

“Rates have really been driving the car for equities the last few weeks,” said Ross Mayfield, an investment strategist at Baird.

That uncertainty comes as an unruly bond market could put pressure on stocks. Treasury yields have marched higher for much of the summer, driven by concerns about rising oil prices, growing U.S. budget deficits and a deluge of tech-company bonds now competing for investors’ cash. Last week, the rout went global, pushing yields to multiyear highs in Japan, Germany and the U.K.

Higher bond yields can drag on stock prices and lift borrowing costs for companies and consumers across the economy.

Rising prices remain the top concern for bond traders, and continued fighting between the U.S. and Iran has done little to ease those worries. The national average price of diesel climbed to a record of $5.850 on Friday, according to AAA. That is up from $3.712 a year ago.

Investors will get more insight on the path of prices this week, with the much-awaited consumer-price index report due Friday and a reading on producer prices Thursday.

With another blockbuster earnings season in the books, some analysts have also warned that any boost from the third-quarter reports due in the coming months could be minimal. Back-to-back quarters of standout profits have raised expectations and made it especially difficult to impress traders. Custom-chip company Broadcom, for example, said Wednesday that it more than tripled its earnings and nearly doubled its revenue. Shares slipped 2.7% the next session.

Many analysts note there are plenty of reasons not to panic. The economy is in impressive shape, thanks to a healthy labor market and the rippling effects of the artificial-intelligence investment boom. Profits are booming at America’s biggest companies. The Cboe Volatility Index has dropped to its lowest levels of 2026. Credit spreads are tight, a sign bond investors aren’t concerned about economic conditions that could hurt companies.

But the mood has shifted from the euphoria that felt tangible when the Nasdaq was notching back-to-back records early this summer. The question, Mayfield said, is whether the fundamentals that have bolstered the bull market so far can stretch the rally into 2027.

“There are more anxieties or uncertainties about the backdrop,” he said. “It does feel like a transitional moment.”

U.K. Economy Unexpectedly Contracts, Posing New Challenge to Government

Gross domestic product was 0.1% lower in January than in the final month of 2024.

Investors are bracing for a bumpier fall stock market due to shifting odds of a Federal Reserve interest-rate increase and other macro challenges.