Rachel Reeves’s policies will see UK economy ‘muddle through’ for next two years, CBI warns
Britain’s economy will ‘muddle through’ this year and next as Rachel Reeves’s tax hikes and Donald Trump’s tariffs hit jobs and investment, the nation’s leading business group says.
The Confederation of British Industry (CBI) has downgraded its forecast for UK growth this year from 1.6 per cent to 1.2 per cent, and from 1.5 per cent to just 1 per cent for 2026.
It marks the latest downbeat verdict on Ms Reeves’s performance as Chancellor – and undermines Prime Minister Keir Starmer’s claim that Labour has ‘fixed the foundations of the economy’.
And the report urged the Government to do more to shift Britain out of ‘low gear’.
CBI principal economist Martin Sartorius said recent rises in employer National Insurance contributions and the national living wage ‘have likely contributed to the recent deterioration in firms’ hiring and investment plans’.
The nation’s leading business group has said Britain’s economy will ‘muddle through’ this year and next in another blow to Chancellor Rachel Reeves
He added: ‘These measures are expected to push up prices, reduce margins, weigh on pay growth, and lower business investment and employment growth over our forecast.’
New figures from the ONS today revealed inflation remained high at 3.4 per cent in May, this was a slight fall from the originally reported 3.5 per cent CPI figure for April. However, that was revised down to 3.4 per cent today too.
The data comes ahead of the Bank of England’s interest rates decision tomorrow, where markets expect base rate to be held at 4.25 per cent.
Mr Sartorius said the impact of US tariffs may be limited – and mainly come indirectly through ‘heightened economic uncertainty, weaker global trade and financial market volatility’.
He said this ‘underscores the need for UK policy measures that strengthen domestic conditions and help shift the economy out of low gear’.
The CBI’s forecast for 2025 and 2026 described the pace of growth as ‘muddling through’. the nation’s leading business group says.
It outlined how Ms Reeves’s Budget changes, which took effect in April, had ‘significantly increased firms’ labour costs’ – especially in sectors such as hospitality and retail.
That will in turn weaken hiring and investment plans, push up prices passed on to consumers and dampen profits as well as wage growth, the forecast suggested.
These higher prices will also affect inflation – expected to remain above 3 per cent mainly thanks to higher energy costs and water bills.
Consumer spending is forecast to pick up, but will be held back by jobs weakness, with unemployment climbing to 4.8 per cent.
But a Treasury spokesman said: ‘We’re investing in Britain’s renewal through our Plan for Change to make working people better off, and the Spending Review set out how we’ll deliver jobs and growth.’
Rachel Reeves presenting her Spending Review to members of Parliament
Non-dom taxes rethink
Rachel Reeves could soften her inheritance tax changes for non-doms, it emerged yesterday.
In April the Chancellor began to charge inheritance tax at 40 per cent on the global assets of non-doms (who live in the UK, but have a permanent home elsewhere, and only pay tax on the money they earn in the UK).
The rule is said to be causing ‘the most heartburn’, the Financial Times reported, amid fears it is driving away wealth creators. So it’s being reviewed by the Treasury, officials told the FT.
How far will interest rates fall? We look at the latest forecasts
The Bank of England cut interest rates from 4.5 per cent to 4.25 per cent last month.
The decision came as little surprise to financial markets, with the 0.25 percentage point cut widely predicted by analysts. It followed the US Federal Reserve holding rates.
May’s meeting saw two Monetary Policy Committee members vote for a bigger 0.5 per cent drop in base rate, which indicates rate cut momentum is building.
The next decision is on 19 June. Markets are currently forecasting a further one or two 0.25 percentage point cuts by the Bank of England before the end of the year. This could mean interest rates reach 3.75 per cent by Christmas.
Future base rate decisions are likely to hinge not just on the rate of inflation, but also on the health of the overall economy, particularly in light of potential global trade wars.
The UK economy contracted by 0.3 per cent month-on-month, according to the latest figures from the ONS. This was worse than the 0.1 per cent decline anticipated by Bloomberg consensus.
The April pullback marks the first time GDP has declined significantly on the month since October 2024.
The Bank of England opted to cut interest rates to 4.25% in May. Its next decision is on 19 June
- What next for interest rates?
- The base rate and the Bank of England
- What’s happened to inflation and interest rates
- What a base rate cut would mean for savings and mortgage rates?
- What should savers do?
- What next for mortgage rates?
- Will borrowers benefit from future base rate cuts?
- Best mortgage rates and how to find them
What next for interest rates?
At present, forecasters are pricing in one or two further interest rate cuts between now and the end of this year. This could see base rate fall to 3.75 per cent by the end of 2025 if the central bank continues with its 0.25bps cuts.
The market consensus is shared by many, although there are some that think base rate may be cut only once and will finish the year at 4 per cent.
However, there are some big organisations that are forecasting that the Bank of England will cut rates below the market consensus.
Analysts at Morgan Stanley are still predicting that UK interest rates will reach 3.25 per cent by the end of the year.
The US bank forecasts the Bank of England will keep cutting interest rates through the early months of next year with interest rates settling at 2.75 per cent in the first half of 2026.
Meanwhile, economists at Capital Economics say base rate will fall to 3.5 per cent by early 2026.
Paul Dales, chief economist at Capital Economics said: ‘This week’s labour market release was softer than expected and as a result, a cut in August suddenly looks more likely again.
‘Our forecast is for a cut in August. And we still think rates will be cut to 3.5 per cent early next year.
‘In fact, it’s becoming possible that they eventually fall further than that, perhaps to 3 per cent.’
Looking even further ahead than late 2025 and early 2026, economists vary on where they think interest rates will level off.
Santander, for example, thinks interest rates will remain between 3 per cent and 4 per cent for the foreseeable future.
However, economists at Oxford Economics are predicting base rate will eventually fall to 2.5 per cent in 2027 where it will broadly remain throughout 2028 and 2029.
The base rate and the Bank of England
The Bank of England moves what is officially known as bank rate but more commonly called base rate to try to control inflation.
Base rate is the single most important interest rate in the UK. It determines the interest rate the Bank of England pays to commercial banks that hold money with it and therefore influences the rates those banks charge people to borrow money or pay on their savings.
The theory is that raising interest rates lifts the cost of borrowing for individuals and businesses and thus reduces demand for it, slowing the flow of new money into the economy and applying the brakes.
In contrast, cutting interest rates lowers the cost of mortgage rates and other borrowing and increases demand, pushing the accelerator on the economy.
Higher savings rates also make saving more attractive, while lower rates encourage spending over setting money aside.
The MPC sets interest rates to try to keep consumer prices inflation (CPI) at the Bank and Government’s 2 per cent target.
> Interest rate rise and fall calculator: How moves affect your payments
Cause and effect: Inflation and wage growth are both factors that could determine what the Bank of England will do with base rate in the future
What’s happened to inflation and interest rates
A major inflation spike over recent years saw CPI rocket into double-digit territory, driven by the aftermath of the disruptive Covid lockdowns combined with an energy price crisis triggered by Russia’s invasion of Ukraine.
This saw the Bank of England raise base rate rapidly from its record low of 0.1 per cent, reached during the Covid pandemic years.
The first move up to 0.25 per cent came in December 2021 and a sharp series of rises from the MPC followed, driving base rate all the way up to 5.25 per cent in August 2023.
Rates were then held at 5.25 per cent until August 2024, when they were cut to 5 per cent. The next cut was to 4.75 per cent in November 2024 and then to 4.5 per cent in February.
The Consumer Prices Index rose by 3.5 per cent in the 12 months to April 2025, according to the ONS, up from 2.6 per cent in the 12 months to March.
Higher than expected inflation could lead to MPC members refraining from rate cuts.
The central bank expects inflation to stay temporarily above its 2 per cent target but fall back to target over the coming 12 months.
Mortgages and savings: Check the top rates you can get
The Monetary Policy Committee, led by Andrew Bailey, voted to cut base rate to 4.25 per cent in May
What a base rate cut would mean for savings and mortgage rates?
Many people assume that savings rates and mortgage rates are directly linked to the Bank of England base rate.
In reality, future market expectations for interest rates and banks’ funding and lending targets and appetite for business are what really matters.
Market interest rate expectations are reflected in swap rates. A swap is essentially an agreement in which two banks agree to exchange a stream of future fixed interest payments for another stream of variable ones, based on a set price.
These swap rates are influenced by long-term market projections for the Bank of England base rate, as well as the wider economy, internal bank targets and competitor pricing.
In aggregate, swap rates create something of a benchmark that can be looked to as a measure of where the market thinks interest rates will go.
Current swap rates suggest that mortgage rates won’t fall much further over the coming years.
As of 12 June, five-year swaps were at 3.67 per cent and two-year swaps were at 3.65 per cent.
Any borrowers hoping for a return to the rock bottom interest rates of 2021 will likely be disappointed. On the flipside, savers will be reassured that rates are not expected to plummet to the depths again.
It’s worth pointing out that while swap rates are a good metric for where markets think interest rates are going, they also change rapidly in response to economic changes.
Richard Carter of Quilter Cheviot adds: ‘Swap rates are a useful indicator of current expectations, but it is important to remember they are no better at predicting the future than any other economic indicator. The economic outlook can change very quickly and very dramatically.’
> Saving and banking: Read the latest on savings rates and top deals
What should savers do?
Experts foresee savings rates falling.
Savers can still get up to 4.75 per cent in an easy-access savings account and the best fixed rate savings offer up to 4.45 per cent.
Rachel Springall, finance expert at Moneyfacts said: ‘Savers are the ones who feel the force of cuts to interest rates, and to add insult to injury, will see no rise to any personal tax or savings allowances in the short-term, making cash Isas increasingly attractive.
‘Those savers who use their interest to supplement their income will feel overlooked if rates plummet.
‘In December 2021, the average easy access rate stood at a pitiful 0.2 per cent and it took months for this to rise above a measly 1 per cent – even though the Bank of England base rate had risen from 0.1 per cent to 2.25 per cent over that time.
‘Safe to say, it’s understandable that savers feel hard done by, barely seeing a return on their money and in fact, watching the true value of their cash eroded by unprecedented high inflation.
‘This could in turn, create an almost apathetic attitude among savers today, even as the average easy access account pays around 2.75 per cent, bank base rate is higher.
‘Shockingly, there are UK current or savings accounts out there earning no interest whatsoever.’
The good news is that with inflation at 3.5 per cent, it means savers who hold their cash in the top paying accounts will still be making a real return, albeit before tax.
Our savings tables show the best easy-access savings, top cash Isas and fixed rate savings deals.
The advice to savers has been to keep on top of the changing market if they want to secure a competitive deal.
Springall adds: ‘Challenger banks are offering attractive returns and it would be unwise to overlook them when they have the same protections in place as a high street bank.
‘Savers need to proactively keep on top of the best rates and review their pots regularly to see if they are getting a raw deal.’
What next for mortgage rates?
Mortgage rates have been drifiting upwards over the past couple of weeks as lenders re-price due to changes in sonia swap rates.
However, this is likely to stop and even reverse over the coming weeks as swaps have been falling this month.
The lowest fixed rate mortgages are currently just below 4 per cent and most borrowers will find they will be able to secure a rate of between 4 and 5 per cent depending on their deposit or level of equity.
Speaking to This is Money in a recent interview, property expert Phil Spencer said: ‘Predicting mortgage rates is a little easier, as the mortgage industry keeps a running tally of where it expects the Bank of England base rate to go.
‘While this measure – known as the swap rate – is constantly being updated, it does give useful clues as to the direction of travel for mortgage interest rates.
‘The swaps market is currently suggesting that there will be one more cut to the base rate in the second half of 2025, and this should lead to more mortgage rates that start with a 3 rather than a 4.
‘The picture for this time next year is less clear, but if inflation calms down from its current spike we should see mortgage rates continue to ease down – though it’s unlikely they’ll go back below 3 per cent any time soon.’
Will borrowers benefit from future base rate cuts?
Future base rate cuts are already largely baked into fixed rate mortgage pricing and means most borrowers won’t notice much difference when it comes to their mortgage rates – even with further base rate cuts down the line.
The bulk of outstanding residential mortgages are fixed rate and for the vast majority of these people, the base rate change won’t have any immediate impact anyway until their fixed term ends.
The mortgage borrowers who stand to benefit the most are those on tracker and variable rates.
Variable rate mortgages include ‘discount’ rates and also standard variable rates (SVRs). Monthly payments on all these types of loan can go up or down.
Tracker rates follow the Bank of England’s base rate plus a set percentage, for example base rate plus 0.5 per cent. They often come without early repayment charges, allowing people to switch whenever they like without incurring a penalty.
Standard variable rates are lenders’ default rates that people tend to move on to if their fixed or other deal period ends and they do not remortgage on to a new deal.
These can be changed by lenders at any time, and will usually rise and fall when the base rate does – but they can go up or down by more or less than the Bank of England’s move.
According to Moneyfacts, the average SVR is 7.48 per cent, which is a lot higher than the average of 4.4 per cent in December 2021 when base rate was just 0.1 per cent – but it will vary from lender to lender.
