The UK economic outlook could brighten over the next two years as the economy stands to benefit from easing trade tensions and lower uncertainty arising from potential trade agreements with some of its key trading partners according to KPMG’s European Economic Outlook.
A temporary pick up in UK headline inflation is also set to ease “by the middle of next year, with inflation set to return to 2% by the middle of 2026.”
Lower inflation will likely give the Bank of England space “to push through a series of steady rate cuts through 2025 and 2026, potentially bringing base rates to 3.25% by the end of 2026.”
Investment represents Gross Fixed Capital Formation, inflation measure used is “the CPI and the unemployment measure is LFS.”
Yael Selfin, European Chief Economist at KPMG, said:
“The US trade agreement puts the UK in a unique position in Europe, which may help ease some worries about further tariffs arriving in the summer. However, UK businesses will need to be mindful of indirect impacts through rising trade tensions in other parts of the global economy as well as potential supply chain distortions affecting operations.”
Europe faces a modest growth outlook in the short term, “as uncertainty weighs on business investment and consumer confidence, with Eurozone GDP expected to increase by around 0.9% in 2025 and 1.1% in 2026.”
The picture is mixed however, with “subdued overall growth masking divergent performances across the continent.”
European economies are shaped by “differences in economic fundamentals, as well as fiscal constraints and exposure to current geopolitical headwinds .”
Southern and Eastern European economies “such as Spain and Poland are performing strongly, thanks to robust domestic demand, targeted investment, and solid labour market performance.”
In contrast, many core economies “such as Germany and France continue to face structural and fiscal constraints that could limit their growth.”
A negotiated US and EU trade agreement “may offer only a limited upside to growth of up to 0.1% in 2026 as a return to largely tariff free trade may no longer be possible.”
In the meantime, more uncertainty “about the scope of ongoing trade negotiations and the potential compromises could stifle investment growth.”
An alternative downside scenario which sees “a return to higher headline tariff rates could particularly impact small open and trade intensive economies such as Ireland, Switzerland and Germany, which could see GDP declines of up to 1.4%.”
Yael added:
“Europe remains vulnerable to an escalation of tariffs, particularly on pharmaceuticals, which make up a large share of exports for a number of European economies. This continuing uncertainty is creating a degree of cautiousness in business planning and investments.”
A changing geopolitical environment is “driving a shift in European defence spending, with governments across the continent announcing plans to devote higher levels of funding.”
Initial increases are likely to focus on “procurement spending, funded by increases in borrowing.”
A commitment to increase borrowing may put “further strain on government finances, potentially creating more pressure on highly indebted European governments and hastening the need to move away from debt finance.”
A sustainable position could involve “a greater balance towards current spending, which could coincide with defence spending moderating to around 2.5% of GDP across Europe.”
This would require governments to “enact potentially unpopular increases in taxation or spending cuts to pay for more funding on defence.”
Yael concludes:
“The pivot to defence may offer an opportunity to provide greater focus on European research and development. This in turn could mean positive spillover opportunities for dual-use technologies, as well as research-intensive defence subsectors such as aerospace, cybersecurity, advanced robotics, and autonomous drones.”