OECD Lowers UK Growth Forecast to 1.3%, Citing Debt Costs and US Tariffs

The Organisation for Economic Co-operation and Development (OECD) has warned that both high government debt interest payments and rising US tariff barriers will dampen the United Kingdom’s economic expansion over the coming years. In its latest Economic Outlook, published on 3 June 2025, the OECD trimmed its forecast for UK growth in 2025 from 1.4% to 1.3%, warning that Britain’s “very thin” fiscal buffer leaves it exposed to shocks and limited policy flexibility. The think tank also cut its 2026 projection from 1.2% to 1.0%, urging Chancellor Rachel Reeves to consider a balanced combination of targeted spending cuts and revenue-raising measures in the upcoming Spending Review. (theguardian.com, thetimes.co.uk)

This article unpacks the OECD’s analysis, examines the fiscal challenges facing the UK, explores how US tariffs on British exports are compounding headwinds, and surveys the global growth outlook that underpins these downgrades. We also consider proposed solutions—such as closing tax loopholes, reforming council tax, and prioritizing public investment—to rebuild Britain’s fiscal resilience and sustain long-term growth.

The OECD’s Revised UK Growth Forecasts

In March 2025, the OECD had projected UK real GDP growth of 1.4% for the year. By June, that forecast was cut to 1.3% due to two primary factors:

1. Rising Interest Payments on Government Debt: The UK’s public debt has swelled to over 100% of GDP, and, with gilt yields having climbed since late 2023, annual interest payments on government debt are now estimated to exceed £90 billion (approximately 3.5% of GDP) in 2025–26—levels unseen since the early 2000s. (oecd.org, reuters.com)
2. US Tariff Barriers: Under the Biden administration’s continuation of Trump-era tariffs, and fresh measures announced in early 2025, the US imposed 25% tariffs on UK-manufactured cars, steel, and aluminum. These duties have disrupted export markets for key British manufacturers—especially the automotive and metalworking sectors—reducing net exports and undercutting business confidence. 

While the UK economy ended Q1 2025 on a surprisingly strong note—growing 0.7% quarter-on-quarter—momentum is expected to fade as these headwinds intensify. The OECD forecasts GDP growth of 1.0% in 2026, down from 1.2% projected in March 2025. Coupled with persistent inflation of around 3.8% (as of May 2025), real incomes are under pressure, further dampening consumer spending and private investment.

UK Economic Context: Recovery Tempered by Limits

Recent Performance

• Q1 2025 Growth: The Office for National Statistics (ONS) reported that GDP rose 0.7% between January and March 2025, buoyed by consumer services (retail, hospitality) rebounding strongly after a mild winter and some recovery in manufacturing output following supply-chain disruptions. Business investment ticked up 0.4% quarter-on-quarter, reflecting delayed capital spending that had been postponed in late 2024.
  
• Inflation and Monetary Policy: Headline inflation stood at 3.8% in May 2025—down from a peak of 6.2% in mid-2023 but still above the Bank of England’s 2.0% target. In response, the Monetary Policy Committee (MPC) maintained Bank Rate at 5.25% in June 2025, indicating any rate cuts would need to await more persistent disinflation. Governor Andrew Bailey warned that trade tensions and global costs could keep inflation elevated longer, reducing room for monetary easing.

Public Finances and Fiscal Rules

• Debt-to-GDP Ratio: The UK’s public sector net debt reached 104% of GDP in 2024–25, compared to around 85% in 2019. Rising interest costs—driven by both higher real yields and increased borrowing to fund pandemic-era support—have placed severe strain on the public finances. The OECD notes that “sizeable primary deficits, elevated interest payments and lower growth will keep public debt ratios high and rising in many OECD economies over 2025–26”, and the UK is one of the most exposed. 
• Fiscal Rules: Chancellors under the current framework commit to two primary rules:
  
  1. “Fiscal Mandate”—the public sector borrowing requirement (PSBR) must fall below 3% of GDP by the end of the rolling five-year forecast period.
     
  2. “Debt Rule”—public sector net debt as a percentage of GDP must be falling by March 2025 (the initial target date), and by March 2028.
     
• In March 2025, Chancellor Rachel Reeves announced £14 billion of fiscal tightening measures—including £4.8 billion in welfare cuts—to restore headroom against these self-imposed rules. Despite this, the spring Budget showed a deficit of 4.5% of GDP in 2024–25, above the 3% fiscal mandate ceiling. The combination of lower growth forecasts and still-high interest payments risks breaching these rules in 2026–27. 

Spending Review and Chancellor Reeves’s Response

Fiscal Strategy

Facing limited fiscal space, Chancellor Rachel Reeves has emphasized a balanced approach:

• Targeted Spending Cuts: The OECD specifically recommended that any spending cuts be “targeted” to non-essential or lower-priority areas rather than across-the-board freezes. Areas under scrutiny include consultancy budgets, some departmental administration costs, and non-statutory grant programs.
• Revenue Enhancements: Reeves is under pressure to close tax loopholes—such as those allowing high-net-worth individuals to avoid Capital Gains Tax—and to review council tax bands based on updated property values, potentially raising additional revenue without increasing headline income tax rates. Currently, council tax in England is based on 1991 property valuations, and in Wales on 2003 values—both of which lag well behind current market rates. (au.news.yahoo.com)

In a response to the OECD’s June 2025 report, Reeves stated: “I am determined to go further and faster to put more money in people’s pockets through our plan for change.” She argued that recent trade deals—including agreements with the EU, US, and India—would open up new export opportunities and cushion the blow from tariffs, adding that public investment in infrastructure (transport, broadband, green energy) would spur long-term growth. 

Defence and NHS Commitments

• Defence Spending: The UK has committed to maintaining defence spending at 2.5% of GDP in real terms over the next five years, reflecting geopolitical concerns—especially the ongoing conflict in Ukraine and tensions in the Indo-Pacific. This pledge ties up billions in the defence budget, limiting room for other discretionary spending.
• NHS Funding: Labour’s 2024 manifesto promised to reduce waiting lists in the National Health Service (NHS). Meeting that pledge will require additional capital for hospital upgrades, staff recruitment (nurse and doctor pay increases), and technology investments (e.g., AI-driven diagnostics). The expectation is that the NHS will absorb £10–£12 billion of new funding over the next Spending Review period, placing further pressure on the overall public spending envelope.

Balancing these high-profile commitments against fiscal rules is one of the greatest challenges for this Spending Review, set to be delivered in mid-June 2025.

Trade Tensions: US Tariffs and Global Uncertainty

Trump-Era Tariffs Continue to Bite

Although Donald Trump left the White House in January 2021, many of his trade measures remain in place. Since returning to office in January 2025, President Trump has escalated tensions:

• 25% Tariffs on UK Cars: Applied in March 2025, these duties target British auto manufacturers, particularly premium brands such as Jaguar Land Rover and Mini. Exports to the US market—worth approximately £4.5 billion in 2024—have seen unit shipments fall by 12% in Q1 2025, as US dealers struggle to absorb the extra costs.
  
• 25% Tariffs on Steel and Aluminum: American policymakers have argued these tariffs protect domestic producers, but UK steelmakers like Tata Steel report losing contracts—total UK steel exports to the US fell from £340 million in 2023 to £255 million in the year to April 2025.
  
• Threats on Digital Services: In May 2025, President Trump threatened 100% tariffs on US imports of films from the UK, putting the British film industry—one of the largest exporters of creative content to the US—on high alert. Although not yet implemented, the threat itself has injected uncertainty into negotiations for a broader UK-US trade agreement.
  

While the UK has avoided direct retaliation—Labour’s Chancellor Reeves has preferred to seek negotiated concessions, such as offering to reduce the UK’s Digital Services Tax (DST) in exchange for lower US metal tariffs—the keep-quiet approach has not prevented export volumes from sliding. The wider impact is felt through business sentiment, which the OECD notes is “deteriorating” as firms factor in higher input costs and uncertain trade rules. 

Impact on Business Investment

• Automotive Sector: Companies are delaying investment in UK production facilities. Ford’s Halewood plant, which assembles engines for US-bound vehicles, has postponed an £80 million upgrade. The UK government has responded with a £200 million support package for battery-electric vehicle (BEV) production, but this still leaves headwinds for internal combustion engine (ICE) models that dominate export volumes.
  
• Steel and Aluminum: The domestic steel industry has lobbied for compensatory measures. The British Steel Pension Scheme—the largest pension fund in Europe—warned that sustained tariffs could force a consolidation or closure of some UK steel mills if alternative markets (e.g., the EU) cannot absorb the excess supply.
  
• Consumer Confidence: Surveys by the Confederation of British Industry (CBI) show that net optimism among manufacturers fell to –15% in May 2025, down from +5% in January 2025. Service-sector firms, which rely on imported components, have also reported higher input costs due to lingering supply-chain frictions, even for goods sourced from Asia or Eastern Europe. (oecd.org)
  

Public Finances: The Thin Buffer and Rising Interest Payments

Debt Interest Payments

• Record Costs: With the UK’s 10-year gilt yield averaging 3.8% in May 2025 (up from 1.5% in mid-2022), debt servicing costs have skyrocketed. The Institute for Fiscal Studies (IFS) projects that annual interest payments on public debt will hit £97 billion in 2025–26—equivalent to paying every person in the NHS for nearly six months. This contrasts with £49 billion in interest payments in 2021–22, illustrating how quickly the burden has doubled.
  
• Limited Headroom: The Treasury’s own forecasts indicate that for every 1 percentage point rise in the average gilt yield, the UK government’s annual debt interest bill would increase by £15–£20 billion. Given this sensitivity, any further upward pressure on yields—perhaps from global trade tensions or domestic fiscal slippage—could blow a hole in the budget, forcing additional cuts or tax rises.

Revenue Shortfalls and Spending Pressures

• Tax Revenues: Despite Tax Day 2025 raising an extra £12 billion through higher National Insurance and corporation tax, the expansion has not kept pace with rising debt-service obligations. Total receipts remain 2% below pre-pandemic trends, after adjusting for the demographic shift of an aging population requiring more public services.
  
• Real-Term Cuts in Non-Essential Spending: Departments outside Health, Defence, and Education collectively saw real-term budget cuts of 8% between 2022–23 and 2024–25. Cold weather payments, child benefits, and certain universal credit top-ups were reduced to free up resources for higher-priority areas, but this has left vulnerable households with less financial cushioning.

In its June 2025 outlook, the OECD stressed that “the state of the public finances is a significant downside risk to the outlook if the fiscal rules are to be met”, urging the UK to rebuild a “modest buffer” to absorb future shocks.

Fiscal Options: Tax, Spending, and Council Tax Reform

Closing Tax Loopholes and Broadening the Base

• Capital Gains Tax (CGT) Alignment: One widely discussed measure is aligning CGT rates more closely with Income Tax rates. Currently, the higher CGT rate is 28% (for residential property) versus the top Income Tax rate of 45% on earnings. Closing this gap could raise an estimated £6–£8 billion per year without altering headline rates on wages or corporate profits.
  
• Digital Services Tax (DST) Negotiations: The UK introduced a 2% DST on large digital firms (primarily US tech giants) in 2020, raising £800 million annually. In May 2025, under pressure from US negotiators, the UK offered to reduce the DST to 1% in exchange for lower US auto and metal tariffs. If an agreement is reached, the UK Treasury may need to offset the lost revenue—perhaps by widening the net on other digital services or raising R&D tax breaks.

Reforming Council Tax Bands

• Outdated Valuations: English councils still calculate tax on the market value of properties as of April 1991. As a result, areas with rapid house-price growth (e.g., London, the South East) pay far less relative to current values than regions with stagnant markets.
  
• Potential Uplifts: The Institute for Fiscal Studies estimates that updating council tax bands to April 2025 values could raise an additional £3.5 billion per year. However, there is political resistance, with many local authorities concerned about sudden spikes in household bills—particularly for older, lower-income homeowners on fixed incomes.
  
• Transitional Relief: One compromise is a phased reform over five years, capping annual increases at 5% for properties that would move into higher bands. This would generate revenue while smoothing the impact for vulnerable homeowners.

The OECD highlighted these reforms as relatively low-hanging fruit, noting that “re-evaluating council tax bands based on updated property values” would help shore up local government finances and reduce reliance on central grants. 

Targeted Spending Cuts and Efficiency Gains

• Administrative Streamlining: The OECD recommends consolidating overlapping programs—such as multiple regional skills initiatives and duplicative R&D grant schemes—into single hubs to reduce back-office costs. Early examples in the Northern Powerhouse and the West Midlands Combined Authority have shown 10–15% savings in administrative overheads.
  
• Immigration Enforcement: Tightening the “right to work” checks and deportation processes was projected to save £2.2 billion in welfare and housing costs in 2024–25. Additional efficiency in the Home Office is expected to yield a further £1.5 billion over the next three years.

In June 2025, Treasury sources indicated that roughly £5 billion of the required £10 billion savings in the Spending Review would come from administrative streamlining, including a deeper review of procurement contracts across departments.

‘Modest’ Global Growth Outlook

OECD’s Global Forecasts

The June 2025 OECD Economic Outlook projects world GDP growth of 2.9% in both 2025 and 2026—down from 3.3% in 2024 and below pre-pandemic norms. Key drivers of this slowdown include:

• Trade Policy Uncertainties: Tariff wars led by the US (particularly new duties on China and reimposed trade barriers on Europe) have reduced trade volumes; global trade growth is now projected to be 1.8% in 2025—down from 3.7% in 2023. (wsws.org)
  
• Tighter Financial Conditions: Central banks in major economies (US Fed, ECB, Bank of England) are reluctant to cut rates until inflation is firmly under control, raising borrowing costs and dampening investment.
  
• Slower Emerging-Market Growth: China’s economy is projected to slow from 5.0% growth in 2024 to 4.7% in 2025 and 4.3% in 2026, partly due to a property sector slump and weak consumer confidence. India remains a relative outlier with 7.5% projected growth.

Impact on the UK

As a highly open economy, the UK is particularly sensitive to fluctuations in global demand and trade volumes:

• Export-Dependent Sectors: Industries such as pharmaceuticals (exports of £75 billion in 2024), automotive (£32 billion), and aerospace (£18 billion) rely on robust external markets. A global slowdown reduces orders from the EU, North America, and Asia, leading to factory layoffs and weaker capital expenditure (capex).
  
• Financial Services: London’s role as a global financial hub—valued at £70 billion in annual exports of financial services—faces headwinds from slower worldwide growth and tighter regulatory scrutiny post-Brexit. The OECD suggests that “elevated equity valuations and financial vulnerabilities” could amplify shocks if consumer confidence falters.
  
• Tourism and Education: Lower global growth dampens discretionary spending on travel and foreign study. In 2024, the UK received around 40 million overseas visitors; a mild downturn in outbound tourism from Europe and North America is expected to reduce inbound numbers by 2–3% in 2025, costing the economy up to £1.5 billion in lost spending.

Policy Recommendations and Longer-Term Prospects

Fostering Investment and Productivity

The OECD’s June 2025 report underscores that “weak investment has held back growth”, particularly in research & development (R&D) and green technologies. On average, R&D spending across advanced economies is 2.5% of GDP, while the UK currently invests 1.9% of GDP, lagging behind Germany (3.2%) and the US (2.7%). Boosting R&D tax credits and improving collaboration between universities and industry are key to lifting long-term productivity.

Strengthening Fiscal Discipline

To reduce the debt ratio, the OECD recommends:

1. Rebuilding a Small Fiscal Buffer: Even a surplus of 0.5% of GDP (around £15 billion per year) would provide cushion against future shocks (e.g., a deeper global slowdown or a surge in energy prices).
   
2. Healthcare and Pension Reforms: With the NHS pension bill expected to rise from £65 billion in 2024–25 to £85 billion by 2030–31 (in real terms), and the state pension bill rising from £120 billion to over £150 billion by 2030–31, long-term reforms focused on sustainability are essential. Options include gradually raising the state pension age to 68 by 2035 (already legislated) and exploring revenue streams for social care such as a social insurance levy.
   
3. Decentralization of Spending: Allowing local authorities more fiscal autonomy—coupled with strict borrowing controls—could improve efficiency and accountability in public services.

Trade Policy Engagement

While new trade agreements with the US, EU, and India offer opportunities, the UK must also:

• Negotiate Tariff Reductions: The UK and US framework deal announced in May 2025—which reduces US tariffs on British cars from 25% to 10% under an annual quota of 100,000 vehicles—must be ratified and expanded to other sectors (e.g., steel, aluminum). In return, the UK will remove tariffs on US ethanol and expand beef quotas.
  
• Diversify Export Markets: Beyond the US and EU, fostering trade relations with Southeast Asia (e.g., Malaysia, Viet Nam), Latin America, and Sub-Saharan Africa can mitigate reliance on any single region. The UK’s membership in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), effective November 2024, could boost trade with Asia-Pacific economies by up to 5% over five years.
  
• Develop Non-Tariff Competitiveness: Investing in digital infrastructure and streamlining customs processes at ports (e.g., Liverpool2, Southampton) can reduce non-tariff barriers, making British exporters more competitive even when facing residual tariffs.

Council Tax Revaluations: A Rare Revenue Opportunity

The Case for Reform

Under the current system, 33 million English households pay council tax based on property values as of April 1991. Over the past three decades:

• National average house prices have increased by 420%, but council tax bands remain anchored to those 1991 values.
  
• Consequently, London boroughs and the South East—where property values soared—effectively pay relatively less council tax than regions like the North East, where prices have stagnated.

A one-off revaluation, updating property values to April 2025 levels, could:

• Generate an extra £3.5 billion per year in local authority revenue.
  
• Improve fairness by shifting part of the tax burden toward higher-value properties.
  
• Reduce the need for council tax referendums (required if a local authority seeks to raise rates beyond the 2% cap), allowing councils more predictable funding.

However, political resistance is strong. A sudden jump in bills—potentially 40% for some households—would be unpopular. As a compromise, the government could introduce a five-year phased approach, capping annual increases at 5% for properties that move into higher bands, while holding bills flat for properties whose 1991 band is higher than current values. This transitional relief could secure broad support.

Risks to the Outlook and Downside Scenarios

Further Trade Escalation

If US tariffs on UK auto, steel, and aluminum rise above 25%, or if new tariffs are slapped on other British exports (e.g., pharmaceuticals, aerospace components), the negative impact on UK exports—currently £425 billion in goods and services—could trigger a 0.3–0.5 percentage point additional drag on GDP growth. A reimposition of tariffs on UK whisky or cheese, for example, would reverberate across rural Scotland and the South West, threatening jobs in hospitality and farming.

Interest Rate Shocks

Although the Bank of England’s MPC has signalled interest rates will remain on hold until inflation falls closer to 2%, the risk remains that global inflationary pressures (e.g., from persistent food or energy shocks) prompt the Fed and ECB to keep policy tight, forcing UK yields higher. A 0.25% rise in UK gilt yields could translate into an extra £4–£5 billion in annual debt interest costs, crowding out other spending.

Weaker Productivity Growth

UK labour productivity has grown at an annual average of 0.6% since 2010—well below the 1.2% OECD average. If reforms to boost R&D and digital adoption falter, slower productivity gains would cap real wages, depress consumer spending, and reduce potential growth from the current estimated 1.5% to 1.0% per annum.

Conclusion

The OECD’s June 2025 Economic Outlook paints a cautionary picture for the United Kingdom: sluggish growth, rising debt costs, and trade barriers are eroding the nation’s fiscal headroom. With growth forecasts cut from 1.4% to 1.3% in 2025 (and down to 1.0% in 2026), Chancellor Reeves faces a delicate balancing act in her Spending Review: preserving funding for defence and the NHS, while finding £10–£12 billion for deficit reduction.

Key takeaways from the OECD’s analysis include:

• Public Finances: The UK’s debt-to-GDP ratio of over 100% and annual interest payments nearing £100 billion underscore the urgency of rebuilding a small fiscal buffer.
  
• Trade Tensions: US tariffs on British cars, steel, and aluminum are dragging down exports, reinforcing the need for swift progress on trade negotiations—especially the CPTPP and ongoing UK–US talks.
  
• Domestic Reforms: Closing tax loopholes (e.g., CGT alignment), reforming council tax bands, and streamlining public spending can raise crucial revenue without resorting to headline tax hikes.
  
• Investment and Productivity: Boosting R&D spending, scaling up green infrastructure, and fostering digital transformation are essential to lift long-term potential growth above the dismal 1.0–1.5% range.
  
• Global Context: A “modest” 2.9% global growth forecast for both 2025 and 2026—driven by trade uncertainties and tight monetary policy—means a weaker external environment for UK exporters and financial services.

Ultimately, the UK’s ability to navigate these challenges will depend on a coherent strategy that balances fiscal discipline with targeted investment. By seizing opportunities to reform outdated tax structures and forge new trade partnerships, Britain can strengthen its resilience, maintain momentum toward net zero, and lay the groundwork for sustainable recovery—despite the headwinds of higher debt servicing and geopolitically driven trade barriers.

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photo source: Google

By: Montel Kamau

Serrari Financial Analyst

4th June, 2025