The unexpected growth seen in the UK’s economy towards the end of 2024 provided a rare moment of relief for the Labour government, which has faced consistent economic challenges throughout the year. Data released by the UK’s Office for National Statistics (ONS) on Thursday revealed that the nation’s GDP grew by 0.1% quarter-on-quarter in the fourth quarter of 2024. While this growth was modest, it marked an acceleration compared to the flatlining GDP recorded in the third quarter. The increase in output was stronger than the anticipated contraction of 0.1%, offering hope that the country may avoid the looming threat of a recession as the new year approached.

The figures were especially notable because they defied forecasts, with December alone showing a 0.4% increase in output, exceeding expectations. Despite the positive headline figures, the underlying details of the report present a more complex picture. While some sectors showed growth, the broader trend of stagnation in both the private sector and per capita output raised concerns about the long-term health of the economy.

For the entire year, the UK economy grew by just 0.9%, a stark contrast to the more optimistic projections that had been set out earlier in 2024. The Bank of England’s latest forecast anticipates that the economy will continue to face headwinds into 2025, with growth expectations revised down to a modest 0.7%. This sluggish economic performance casts a shadow over Chancellor Rachel Reeves’ hopes for more robust economic expansion, which had faced a challenging start due to a number of headwinds, including global uncertainty and domestic fiscal policy debates.

However, the small uptick in GDP in the fourth quarter has provided a degree of relief, particularly as the Budget Responsibility Office prepares to release its updated forecasts next month. The data, while modest, may lift the spirits of the government, offering a glimmer of hope that the economy has not yet entered a deeper phase of stagnation or recession. The slight improvement in economic activity could help the Labour Party manage its expectations and approach upcoming fiscal challenges with a bit more optimism. After all, the UK economy is now slightly ahead of where it stood when the Labour Party took office in July 2024.

The chief economist at the ONS commented on the data, noting that the economy is “almost stagnating” with businesses adapting to higher taxes and uncertainty from abroad. He further added that October's budget decisions had led to a growth in public sector activity, though this was accompanied by a decline in private sector output. This dynamic illustrates the ongoing challenges that the government faces, where fiscal stimulus is propping up public sector activity, but private sector investment and spending remain sluggish.

The currency markets responded positively to the data, with the pound strengthening and reaching its highest level in over a week. This movement was largely driven by a weaker US dollar, with the pound rising by 0.9% against the dollar for the week. Nevertheless, while the GDP data provided a temporary boost to market sentiment, the underlying reality of the UK’s economic struggles remains concerning, especially when factoring in the population growth and the persistent decline in per capita GDP.

The ONS data highlighted a second consecutive quarter of contraction in the private sector, underscoring the vulnerability of business activity in the current environment. In contrast, the public sector remained the main driver of growth, with significant increases in spending on healthcare, defense, and public administration. Government consumption rose by 0.8%, but this was offset by flat household spending and a 3.2% decline in business investment. The latter figures were especially troubling, as business investment has long been seen as a key indicator of confidence in the economy. The decline in investment is a sign of deeper concerns within the private sector about the future economic outlook.

Economists from Bloomberg, Ana Andrade and Dan Hanson, commented that while the surprise growth in the fourth quarter indicated that the UK had narrowly avoided a winter recession, the details of the data were far from encouraging. Private demand remains weak, and government spending continues to be the primary source of economic expansion. As they pointed out, the government’s focus on public sector spending is unlikely to lead to sustainable growth without a revival in private sector activity.

The lackluster economic performance is posing a serious challenge to the Labour government’s fiscal ambitions. According to recent reports, the UK’s fiscal watchdog has lowered its growth projections for the UK, raising concerns that Chancellor Reeves will be faced with a small budget deficit. The pressure is mounting as she seeks to balance the need for economic stimulus with the reality of a growing fiscal deficit.

Luke Bartholomew, Deputy Chief Economist at abrdn, stated that it is “hard to see the economy slipping into a technical recession in the short term.” However, he also noted that the Budget Responsibility Office is likely to revise its growth forecasts downwards, which would place even more pressure on the Chancellor to meet her fiscal targets. As Bartholomew explained, the slow growth environment makes it increasingly difficult for the government to achieve its budgetary goals without taking on more debt or cutting back on planned spending.

The government has already unveiled a number of initiatives to improve the supply side of the economy, including controversial decisions such as approving the expansion of Heathrow Airport with a third runway. While these measures are seen as necessary for long-term economic growth, they are unlikely to provide immediate relief. The UK economy is still grappling with the consequences of high interest rates and a general lack of confidence in both the consumer and business sectors.

One of the most contentious issues in the current economic climate is the government's proposed increase in taxes, including a £26 billion rise in employer national insurance contributions. This move has faced considerable pushback from businesses, which argue that it could lead to higher unemployment. The government has defended the policy as a necessary step to shore up public finances, but its potential impact on the economy has raised concerns about the balance between fiscal consolidation and economic growth.

As the Bank of England grapples with a complex economic situation, its decision-making on interest rates remains under intense scrutiny. With inflation still high and economic growth sluggish, the central bank faces a delicate balancing act. Last week, the Bank of England’s monetary policy committee voted in favor of a third rate cut in the current cycle. However, the bank remains cautious, signaling that any further rate cuts will be gradual to avoid stoking inflation. The growing concerns among the more dovish members of the committee are becoming more evident, with some advocating for more aggressive rate cuts to stimulate growth and avoid a deeper recession.

As the UK economy enters 2025, the challenge of revitalizing growth amidst ongoing inflationary pressures and uncertain global conditions remains a formidable task. While the surprise GDP growth in the fourth quarter offers a brief respite, the country’s economic fundamentals remain weak. With the fiscal watchdogs lowering their growth forecasts and the private sector showing little signs of recovery, the Labour government faces an uphill battle in achieving its ambitious economic goals. The road ahead is uncertain, and the government’s ability to navigate these challenges will likely define its economic legacy in the years to come.