2 January 2026: Brexit has deepened the British economy’s flaws

In his New Year's message delivered yesterday, the Prime Minister promised that the country would begin to feel the positive effects of the changes made since Labour took office. He acknowledged that 2025 had been a challenging year, but the benefits of changes like the freeze on rail fares and prescription charges, and the subsidies on energy costs, will make life easier and ease cost-of-living concerns.

However, energy bills are rising for millions of households in England, Scotland and Wales as the new year begins, following Ofgem's slight increase to the price cap.

Prices for those on variable tariffs are rising by 0.2% from now, the equivalent of a £3 annual increase for a household using a typical amount of gas and electricity. Campaigners say this means bill payers are facing another winter of high energy prices, with the latest, albeit small, increase coinciding with the year's coldest period.

Britain remains stuck at the bottom of the G7 for overall investment, despite Labour’s pledge to inject billions of pounds into public spending over the next two years, according to international data. Figures from the OECD show that total investment, combining both public and private spending, stood at 18.6 percent of GDP in the third quarter of the year. That leaves the UK trailing all other G7 nations.

The data underlines a long-running weakness in the British economy. The UK has recorded the lowest investment rate in the G7 in 23 of the past 31 years, a factor widely blamed for poor productivity growth and weak long-term economic performance.

By comparison, Japan recorded the highest investment rate among the G7 at 27 percent, while Germany, despite being in a two-year recession, invested around 20 percent of GDP over the same period.

Labour has made boosting investment a central plank of its economic strategy, pledging to increase public capital spending on infrastructure, transport and house building. Economists at PwC estimate that public investment will rise by £13 billion in 2026–27, marking the most significant two-year increase since the 2008 financial crisis.

However, there are growing concerns that the private sector will not be able to keep pace with this surge in government spending. PwC warned that private investment is expected to stagnate due to weaker business confidence and slower profit growth.

“There will be a much stronger focus on domestic growth levers from the government, particularly public investment picking up at a record pace, but private investment is unlikely to respond as firmly in the near term.

The scale of the challenge is stark. EY estimates that up to 1,000 major investment projects are planned to start or complete by 2040, with government-backed capital spending on track to reach £1.1 trillion. Yet even this would leave a significant funding gap, an issue that will concern the Treasury.

Sir Keir Starmer ends 2025 as the most unpopular British prime minister in polling history, while Rachel Reeves, his chancellor, plumbs similar depths of public dislike. But one thing still surprises the pollsters: the level of apparent hatred felt towards them.

Starmer and Reeves have made plenty of mistakes, as even their allies admit, and the change they promised has been slow in coming. But for technocratic, low-key politicians, the level of contempt they attract from voters is striking.

“I can normally understand where the public is coming from, but I admit this is surprising,” said Luke Tryl, of the More in Common polling organisation. “There’s a real dislike, even loathing, of Starmer and Reeves.”

“In focus groups, people say Starmer is a liar and only said what he thought he needed to say to get elected,” Tryl added. “Reeves is often deemed to be uncaring. People say she’s targeting people who can’t fight back.”

The markets were effectively closed yesterday as the world celebrated the New Year.

Next week will see the return of payroll data to its regular first Friday of the month position for the first time since the Federal shutdown threw data collection into chaos from October 1st to November 12th. However, there was significant follow-through as well.

Employment data released this week showing underlying weakness in America’s jobs market may be the foundation for new interest rate cuts from the Fed early next year, according to UBS.

The final figures for 2025 were expected to show a sufficient increase in the number of workers collecting unemployment benefits to encourage even the most hawkish members of the FOMC to relent and vote for a cut at January's meeting.

Despite falling consumer confidence and rising unemployment, third-quarter economic growth was better than expected, with GDP increasing 4.3% on an annualised basis. Better-than-expected consumer spending was the most significant driver of the strong report, with net exports being the other notable tailwind.

The details of the delayed GDP report were supportive of fourth-quarter growth. Since inventories declined in the quarter, there could be a tailwind from inventory production as consumption has remained strong. On the margin, this supports a better-than-expected growth rate of around 2.5% for the US economy in the final quarter.

President Trump has said he will delay the implementation of tariffs on upholstered furniture, kitchen cabinets, and vanities for one year, amid growing concerns about cost-of-living issues.

Trump signed an order on Wednesday night, during the New Year’s Eve holiday, pausing planned 50% tariffs on cabinets and vanities and 30% tariffs on upholstered furniture.

Trump’s staff have now had time to shift the emphasis of tariffs from exporting nations to individual sectors, which makes eminently more sense, even though it has less “shock value”.

As the makeup of the FOMC goes through a significant shakeup, with more to follow when a new Chairman is confirmed, it's expected to have an overall more dovish outlook. Trump informed the press yesterday that he intends to announce his nomination for Fed Chairman this month.

No matter who is selected, the markets believe the Central Bank's independence will be further eroded.

The dollar index has opened the first trading day of the New Year marginally lower in early Asian trading.

In Germany, many working-class families spent the Christmas holidays in anxiety and are looking into the new year with grim forebodings. Hundreds of thousands have lost their jobs over the course of 2025, or have learned that they will lose them in 2026. They are the victims of war and social cuts, trade war and economic crisis.

The Federal Association of German Industry (BDI) expects production to have declined by around 2% over the whole of 2025. Industry is likely to shrink for the fourth consecutive year. BDI President Peter Leibinger recently spoke of the “deepest crisis in the history of the Federal Republic.” Germany as a business location, he said, was “in free fall.”

Leibinger also explicitly rejected the frequent claim that this was merely a temporary cyclical downturn, a claim advanced not least by the trade unions to placate workers. “This is not a cyclical dip, but a structural decline.” German industry was being systematically hollowed out.

According to projections by a leading credit rating agency, 23,900 companies filed for insolvency in 2025. That is as many corporate bankruptcies as there have been since 2014.

The number of unemployed rose by around 160,000 in 2025, to just under 2.95 million. More will follow. According to a survey by the Institute of the German Economy, 4 out of 10 industrial companies are planning layoffs in 2026. The situation will worsen further, particularly in the automotive and supplier industries and the chemical industry.

Resident ECB hawk, Isabel Schnabel, made a significant attempt to water down her recent remarks, in which she told reporters that she expected the next move in interest rates would be a hike. She told the press earlier this week that she did not expect a hike imminently, or even in the medium term. However, she couldn’t resist adding the caveat that her time span relates to inflation at its current level.

EU member Bulgaria marked its entry into the eurozone on Thursday with a display of euro coins on the facade of the central bank in Sofia and fireworks to celebrate a long-awaited milestone.

As of midnight on December 31st, the Euro became the country’s currency and the Lev was banished into history.

The Euro has begun the New Year on the front foot. That is likely to last as long as the expected divergence in monetary policy by G7 nations continues.

Have a great day!