You didn’t have to be in Davos last week to feel the excitement, or the unease many business leaders faced. While the UK may have played a slightly secondary role in the drama unfolding in the Alps, the threat to the country’s GDP growth was real.
The additional tariffs that were announced on UK exports to the US could have shaved off 0.2 per cent from UK GDP this year, and that’s assuming no retaliation by any party. A potential escalation to a full-blown trade war, even if short-lived, would have most likely triggered a recession across European economies, drastically reducing demand from our collectively largest external market.
Now that the storm has cleared, the outlook remains mixed. While data released last week showed inflation rose to 3.4 per cent in December, we still expect headline inflation to reach the Bank of England’s 2 per cent target by April this year, and from there to either largely stay at that level or even fall below it this year. The Bank’s monetary policy committee members appear split and potentially reluctant to lower rates too fast towards the so-called “neutral rate”.
That may be unfortunate given the lag between a rate decision and the impact on the economy and prices, which may make them overcautious at this stage. Expectations are for a hold in rates at the meeting next month, followed by a 25 basis point cut in both April and July. If the economy weakens more than anticipated, then another cut, perhaps in November, should not be ruled out.
Other ONS data released last week pointed to the UK labour market continuing to soften, with forward-looking survey evidence indicating that employers are signalling their intention to reduce hiring due to higher employment costs. The combination of a relatively weak economic environment, rising uncertainty, and higher costs is likely to push the unemployment rate to 5.3 per cent by the end of 2026 according to our latest estimates.
All this does not rule out a mild pick-up in growth in the first quarter of this year, after a relatively weak second half of 2025. Our latest forecasts expect UK GDP growth to be just under 1 per cent in 2026, not the strong momentum hoped for. Households need to feel more confident and increase spending, and more importantly for long-term growth, you need businesses to boost investment spending alongside strong public sector investment.
While the government puts stronger economic growth as one of its key objectives, the budget late last year offered limited pro-business, growth-boosting measures, and we expect to see continued challenges for broader business investment.
The UK economy has faced a persistent weakness in business investment, which has contributed to sluggish productivity and overall subdued economic growth. Looking back, the main shift in business investment growth appears to have come in 2016, coinciding with the EU referendum result and the associated uncertainty and concerns over market access which played a role in holding investment back.
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While UK business investment has returned to growth since 2022, comparisons with the US underline the scale of the underperformance. Since 2016, UK business investment has expanded around one sixth of the pace seen in the US, where investment was particularly strong in data centres that support the development of generative AI models.
Not all types of business investment have grown at the same pace. Investment in intellectual property, covering software, research and development as well as mineral rights and artistic works, has been the strongest in both the US and the UK, likely reflecting different AI-related investments. However, while other forms of investments have also grown in the US, they declined for much of the past decade in the UK.
UK firms continue to cite uncertainty as a key factor impacting activity. Perceptions of uncertainty rose in 2025, potentially driven by a combination of concerns over the impact of the US tariffs and concerns over further tax increases in the run up to the 2025 autumn budget. More recently, global events in the first few weeks of 2026 have pushed business sentiment onto shakier ground again. Manufacturing and distribution have been amongst the most affected sectors, reflecting both exposure to tariffs and concerns about the potential impact of future taxes on household spending.
Recent data shows a recovery in UK business investment growth despite this uncertainty. However, the headline figure could be misleading as the rise has been almost exclusively driven by only two sectors: information and communication, and more prominently utilities. Over the two years to Q3 2025, while UK business investment grew by an average of 0.9 per cent per quarter, the joint contribution from these two sectors was well over this figure. All other sectors experienced only marginal growth or declines in investment.
Growth in the information and communication sector has likely been driven by the construction of data centres linked to AI. Investment in utilities, meanwhile, reflects repairs to water supply infrastructure and investment in renewable energy, supported by policy changes such as the 2023 change in thresholds that reduced planning requirements for smaller installations, alongside a 73 per cent fall in solar panel costs over the past decade.
Given the relatively narrow base of recent trends in business investment, and the industry specific factors driving it, the outlook for business investment in the wider UK economy remains downbeat. Excluding energy and information and communication, investment across the rest of the economy has fallen since 2023. Uncertainty has played an important part in that disappointing performance.
Looking ahead, there is hope that the bout of uncertainty we experienced at the start of the year will ease. A more stable international environment, an uneventful budget, and a strong domestic policy agenda for UK businesses could make a meaningful difference to business confidence and ultimately UK growth.
Yael Selfin is chief economist at KPMG UK