The UK economy continued to lose momentum in May, as a slowdown in manufacturing and construction outweighed modest gains in services. Business confidence has also continued to deteriorate, inflation is creeping higher and cracks are beginning to show in the labour market.

While some professional services remain resilient, mounting cost pressures, weaker demand and geopolitical uncertainty are fuelling concerns. With the outlook softening, the question is whether the UK economy is experiencing a temporary setback – or entering a more prolonged downturn following two consecutive monthly declines.

UK economy shrank in May

Official figures revealed that UK GDP fell by 0.1% in May 2025, the second successive monthly decline. This contraction largely reflected notable falls in output within production and construction sectors, which more than offset continued growth in services. May’s drop in production largely reflected a particularly poor month for firms involved in oil and gas extraction, car manufacturing and pharmaceuticals. Growth in service sector output was largely driven by a strong month for legal firms and computer programming businesses, offsetting falling retail activity. May’s downbeat outturn means a contraction in GDP across the second quarter is a real possibility, as sinking business confidence amid intensifying geopolitical turmoil will have dampened growth in June, despite a boost from the warm weather.

Business confidence slides further into the red

ICAEW’s Business Confidence Monitor (BCM) for Q2 2025 put confidence at -4.2 on the index, its weakest reading since Q4 2022, and down from -3.0 in the previous quarter. This fourth successive quarterly fall in business confidence was likely driven by historically high tax worries and slower expected domestic and exports sales growth. Confidence among exporters was particularly downbeat (-6.1), falling into negative territory for the first time in almost three years amid US tariffs and growing geopolitical instability (see Chart 1).

The tax burden was cited as a growing challenge by more than half of businesses (55%), close to the previous quarter’s record high (56%) and a six-fold increase over the past four years, from a reading of just 9% in Q2 2021. Customer demand was a key growing concern for 42% of companies, the highest proportion since Q4 2020 and up from 35% in Q1.

Manufacturers and retailers most pessimistic

ICAEW’s BCM survey also found that confidence declined in nine of the 11 sectors surveyed. Manufacturing and engineering firms were most negative with confidence dropping to -14.0 on the index. As consumer confidence remains weak, sentiment also dropped further in retail and wholesale sentiment, and a score of -11.4 in Q2 2025 marked the third consecutive quarter for the sector in negative territory. Retailers’ concern about the tax burden also rose to a new survey record high (60%). The property sector reported an improvement in confidence but, at -6.8, is the third least confident sector, likely reflecting a challenging housing market and weak commercial demand. In contrast, IT and communications (+8.4) remains the most confident sector despite its score easing down from +10.0 recorded in Q1 2025.

UK inflation getting hotter

Official figures suggest that UK inflation rose from 3.4% in May to 3.6% in June, the highest rate since January 2024 (see Chart 2). The largest upward pressure on the headline rate came from fuel prices, which fell only slightly, compared with a much more significant fall in the same month last year. Food price inflation increased to 4.5% in June, the third successive increase and the highest rate since February 2024 as the hot weather hit harvest yields in the month. June’s uptick in inflation is expected to be the start of a slight summer surge in inflation, with skyrocketing business costs and global trade turbulence likely to lift the headline rate moderately higher by the autumn, despite July’s drop in energy bills.

UK jobs market looking increasingly fragile

The UK’s unemployment rate rose from 4.5% to 4.7% in the three months to May 2025, the highest rate recorded since the Spring of 2021. The number of vacancies in the UK fell by 56,000 to 727,000, in the three months to June 2025, the 36th consecutive quarterly decline. The construction sector recorded the largest decrease in vacancies (-31.9%) (see Chart 3), followed by education (-13.7%). The UK’s jobs market has hit a rough patch, with spiralling business costs and a wilting economy likely to mean moderately more job losses in the coming months, as well as reductions in other employment-related costs, including staff training and pay awards.

Implications for accountants, business owners and the economy

Overall, these figures suggest that the UK’s growth trajectory in the near term is likely to tilt downwards as any uplift from higher consumer and government spending is hampered by escalating business caution, amid fears of further tax rises in this Autumn’s Budget.

UK economy – what to watch for next month:

1. On 7 August, the Bank of England’s Monetary Policy Committee are likely to cut interest rates from 4.25% to 4.00%. Alongside its August policy decision, the bank will publish its latest economic forecasts for the UK economy. 
2. The quarterly GDP data, to be released on 14 August, should confirm a major weakening in economic performance in the second quarter of 2025, following 0.7% growth in Q1 2025.
3. The inflation figures for July due out on 20 August could see a slight increase in the headline rate from the latest reading of 3.6% in June.

Read last month’s Economic update: why UK economic conditions have taken a turn for the worse