Britain suffers economic downgrade as steep interest rates bite

High taxes and interest rates will make Britain the slowest-growing economy in the G7 next year, the Organisation for Economic Co-Operation and Development (OECD) has predicted.

Economists at the Paris-based group on Thursday downgraded the outlook for Britain, predicting GDP will rise by just 0.4pc this year and 1pc in 2025 as high borrowing costs and taxes weigh on the economy.

The outlook for next year is the worst of any other major developed economy in the OECD and almost half the 1.8pc growth expected in the US.

Forecasters blamed high taxes and interest rates, as well as rapidly rising public spending, for holding back Britain.

The OECD said: “Welfare spending is set to increase by more than 1pc of GDP, mainly due to the pension triple lock and rising caseloads for health-related benefits… Tax receipts keep rising towards historic highs of about 37pc of GDP.”

The group said Chancellor Jeremy Hunt’s recent cuts to National Insurance “only partially offsets the ongoing fiscal drag from frozen personal income tax thresholds”.

Meanwhile, the decision to make a temporary investment tax break for businesses permanent “less than fully compensates the increase in the statutory corporate tax rate”.

Mr Hunt blamed Britain’s weak growth outlook on the need to fight inflation with higher interest rates.

He said: “This forecast is not particularly surprising given our priority for the last year has been to tackle inflation with higher interest rates.

“But now we are winning that war, growth matters which is why it is significant that last month the IMF predicted the UK will grow faster over the next six years than any European G7 country or Japan.

“To sustain that we need to stick to our plan - competitive taxes, a flexible labour market and far-reaching welfare reform.”

The OECD hailed the Chancellor’s cuts to National Insurance as a sensible measure to encourage more people into jobs but said more needed to be done to combat worklessness.

It said: “Further advancing supply-side reforms while avoiding policy churn is essential to increase potential growth, especially by continuing to address economic inactivity and stagnant investment.”

On the current path, Treasury spending will be 2.9 percentage points of GDP higher than its pre-pandemic levels by 2029, the OECD said.

As well as rising pension and health costs, Britain’s finances are also being strained by the Bank of England’s losses on its quantitative easing scheme. Taxpayers are on the hook to cover these losses and payments made under this arrangement rose to more than 1.5pc of GDP last year. That is far higher than the 1pc paid out in the US or 0.9pc in the eurozone.

It poses a troubling economic outlook for Sir Keir Starmer as he seeks to take office in the forthcoming general election. If he is successful as current polls suggest, the Labour leader looks set to take control of a weak economy with little financial space for him to further raise spending or cut taxes.

The OECD warned that governments around the world are in danger as they keep borrowing to fund rising health and pensions spending.

It said: “In the medium and longer term, the fiscal position is worrying. Governments must address mounting debt and rising expenditure demands due to ageing populations, climate change mitigation, and defence needs.

“Increasing debt-service costs further worsen fiscal sustainability. There is never an attractive time to do this, but conditions enable this rebuilding to begin now.”

The OECD said pensions should be cut to help put the finances on a firmer footing. It said past experience suggested the only way to sustainably cut public spending was to target “politically sensitive areas such as pensions, civil service wages and subsidies, as well as cutting public investment”.