UK businesses brace for tough quarter

[EUROPE] British businesses are bracing for a downturn in output over the next three months, according to the latest survey from the Confederation of British Industry (CBI). The survey’s output expectations gauge fell sharply in May, reaching its lowest level since September 2022. This pessimism is driven by a combination of rising payroll taxes, increased minimum wage costs, and the impact of new US tariffs, all of which are squeezing margins and dampening demand.

Private sector activity has already declined, with the CBI reporting a drop in its activity measure from minus 19 in April to minus 26 in May. Companies are responding by planning to cut hiring, citing the recent £25 billion increase in social security contributions and a nearly 7% rise in the National Living Wage as major cost pressures. The CBI notes that these challenges are compounded by weak domestic demand and ongoing global trade uncertainties.

Despite these concerns, a separate poll from the Institute of Directors (IoD) suggests a more optimistic sentiment among business leaders, with confidence about the UK economy at its highest since August 2024, though still in negative territory. The mixed signals come as the UK government prepares for a crucial multi-year spending review, with economists warning against further tax hikes amid rising government borrowing costs.

Implications

For Businesses:

The outlook signals a tough period ahead for UK firms, particularly in labor-intensive sectors. Higher payroll taxes and wage floors are forcing companies to reconsider hiring plans and potentially scale back operations. Exporters and manufacturers face additional uncertainty from shifting global trade policies, notably the US tariffs, which could erode competitiveness and profitability.

For Consumers:

Consumers may feel the effects through slower job growth and potential price increases as businesses pass on higher costs. Weak demand at home could also translate into fewer new products or services, and a more cautious approach to investment by firms. If companies cut back on hiring, wage growth could stagnate, further dampening consumer spending power.

For Public Policy:

The government faces a delicate balancing act ahead of the June 11 spending review. While there is pressure to support public services, the risk of further tax increases could stifle business activity and prolong economic weakness. Rising government borrowing costs add another layer of complexity, limiting fiscal flexibility and increasing scrutiny of new spending commitments.

What we think

The latest CBI survey underscores the fragility of the UK’s private sector recovery. While headline growth surprised on the upside earlier in 2025, persistent cost pressures and global trade headwinds are clouding the outlook. The divergence between CBI and IoD surveys suggests that while some business leaders see reasons for optimism, the broader base of firms remains cautious.

Policymakers must tread carefully: further tax hikes could undermine both business confidence and consumer demand, just as the economy needs momentum. The upcoming spending review is a critical opportunity for the government to signal stability and restraint, rather than risk exacerbating uncertainty. In the near term, targeted support for vulnerable sectors and a focus on productivity-boosting reforms may help offset some of the negative pressures.

Ultimately, the path forward will require balancing fiscal responsibility with measures to sustain growth and employment. As the global economic environment remains volatile, clear communication and a measured policy response will be essential to restore confidence and support a sustainable recovery.