UK economy shrinks for second month as trade war hits manufacturing

The growth picture has soured after a strong start to the year, with the UK economy shrinking for the second month in a row in May. Gross domestic product (GDP) fell by 0.1% over the month, following a 0.3% drop in April.

Analysts had been expecting a gentle rebound in May following April’s slump. A Reuters poll pointed to a 0.1% increase in GDP. Deutsche Bank and research provider Pantheon Macroeconomics were forecasting the same.

A production slump was the main driver of the GDP fall, with output in the sector decreasing by 0.9% during the month. Construction output also fell by 0.6%. This was partially offset by a 0.1% increase in services output, the largest sector of the UK economy.

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The production slump appears to have been driven at least in part by Donald Trump’s trade war.

The manufacture of auto and pharmaceutical products slumped by 1.3% and 4.2% respectively in May. Metal manufacturing dropped by 1.8%. These are all areas that have been slapped with or threatened by tariffs.

The drop in pharmaceutical production was the biggest driver of the overall manufacturing slump. It may have been driven by frontrunning activity from US customers earlier in the year, as they tried to get ahead of potential tariffs.

Trump has not yet imposed pharmaceutical tariffs, but he has hinted at a levy of up to 200% in recent days.

The UK currently faces a 10% tariff on autos, negotiated down from 25% for a quota of 100,000 cars under the UK-US trade deal. Steel and aluminium exports are still being slapped with a levy of 25%, despite efforts to bring this rate down.

Does the GDP drop put pressure on the Bank of England to speed up rate cuts?

May’s surprise GDP drop means an interest rate cut looks almost certain in August. Most economists were already predicting one, even before today’s data. The Bank of England could now face pressure to speed up the pace of cuts beyond August.

Despite this, Deutsche Bank doesn’t believe May’s GDP drop is a major cause for concern.

“Is the economy at risk of faltering? We don't think so,” said Sanjay Raja, chief UK economist at the investment bank. He points to several indicators which support this view.

The latest data from the purchasing managers’ index points to a rebounding economy, household sentiment is gradually on the rise, and business sentiment has pushed above its long-term average.

Credit conditions look healthy, and there are some “tentative indicators” that the labour market is already stabilising.

“Big picture, it’s also worth taking a big step back,” he said. “If the economy does indeed slow to 0.1% quarter-on-quarter growth in Q2 25, this would still mean that the UK economy had grown by 0.8% in the first half of the year, which would still be pretty healthy.”

For this reason, the Bank of England could place greater emphasis on the labour market than GDP data when considering the pace of future rate cuts. It may conclude that recent GDP weakness is a natural consequence of first-quarter strength – a sort of balancing out.

Growth in the first quarter of the year was higher than expected, coming in at 0.7%, but has been disappointing since.

“We’ve seen a pattern over recent years where the first quarter has recorded much stronger growth than the rest of the year, despite the data being adjusted for seasonal trends. We suspect that seasonal adjustment has become much harder post-Covid and the most recent inflation wave,” said James Smith, UK economist at financial institution ING.

“The Bank of England opted to look through the first quarter strength, commenting instead that activity was probably more or less flat. We suspect it'll reach the same conclusion for the second quarter, where overall quarterly GDP growth is on track for 0.1%.”

Bad news for Rachel Reeves

The latest GDP report is another headache for chancellor Rachel Reeves. Under her fiscal rules, debt needs to be falling as a share of the economy by 2029/30. She is also prohibited from borrowing money to fund day-to-day spending.

When economic growth weakens or borrowing costs (determined by gilt yields) rise, it erodes Reeves’s fiscal headroom – otherwise defined as the amount of leeway she has to increase spending or cut taxes.

Weak growth, high borrowing costs, and expensive policy U-turns mean we are likely to see further tax rises in this year’s Autumn Budget.

“Getting more money in people’s pockets is my number one mission. While today’s figures are disappointing, I am determined to kickstart economic growth and deliver on that promise,” Reeves said.

While the last two GDP reports have shown disappointed monthly drops, things look better on a three-month basis. Real GDP is estimated to have grown by 0.5% in the three months to May 2025, compared with the three months to February 2025.