Rising Energy Costs Threaten UK Growth Despite 1.3% Expansion

The UK economy is forecast to grow in 2026, but rising energy bills and higher borrowing costs will weigh on activity in the second half of the year.

The economy is set to grow 1.3 per cent this year, according to KPMG’s latest economic outlook, after household spending was “supported by warmer weather” while businesses continued to invest in technology.

The consulting firm also estimates the economy will grow 1.4 per cent in 2027.

But spending is set to slow in the second half of the year as households deal with rising energy bills and slow wage growth.

“Households’ spending power is likely to come under increasing pressure,” said Yael Selfin, chief economist at KPMG UK.

“The longer-term challenge is how to sustain stronger growth as the contribution from a growing labour force diminishes.”

Energy prices hit inflation

Higher wholesale gas prices are expected to trickle into household energy bills this autumn, putting renewed pressure on inflation, as the conflict in Iran continues to affect the market.

The Ofgem energy price cap is forecast to rise by roughly four per cent in October. The government’s reduction in VAT on household energy bills is anticipated to only partially offset the increase.

The rise also comes as the Bank of England is expected to hike interest rates in the coming months in an effort to combat higher energy prices, a weaker labour market and subdued domestic inflation.

The Monetary Policy Committee (MPC) opted to hold rates at 3.75 per cent last week, but the base rate is expected to be lifted to 4 per cent at the November meeting.

The Chancellor is also facing a fiscal headache in the upcoming Autumn Budget, having limited scope to provide significant support for both growth and the cost of living.

The rise in borrowing costs following the Iran war has reduced the £23.6bn of headroom recorded at the Spring Forecast by roughly £9bn.

Weak growth and an expected downgrade to the OBR’s projections could reduce it by a further £2bn, leaving Healey with just £12bn in headroom.

Increasing investment

Analysis from KPMG also suggests increasing capital spending in England’s seven most underfunded regions, including the Midlands and the North East, could also close the productivity gap and support stronger long-term growth.

Selfin said: “Greater public investment has an important role to play in narrowing the UK’s longstanding regional economic divide, particularly where gaps in infrastructure are holding back productivity.

The effectiveness of individual projects, alongside stronger private sector investment and credible local growth strategies, will be crucial in turning additional public spending into sustained improvements in productivity and living standards.”

The consultancy estimates that spending around £47bn in additional investment in those regions could get them up to the current national average level of capital and yield £25bn in GDP over five years.

By City AM

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