Market pricing of UK growth is too optimistic

UK growth faces structural headwinds as migration slows, the workforce ages and productivity remains weak. These demographic shifts challenge official forecasts and have important implications for fiscal sustainability, gilts, equities and sterling.

Since the global financial crisis, growth in the labor supply has been instrumental for overall growth, particularly as UK productivity growth has stagnated. However, this growth driver is starting to fade. This has direct investment implications. Today’s workforce projections are potentially too optimistic. Macro forecasts, not least growth and taxes, are therefore also potentially too optimistic.

Immigration is likely to stay low

Net inward migration has been a key source of support for the labor force. However, it is declining. According to data from the Office for National Statistics, net inward migration decreased to 204,000 by mid-2025 from a peak of 924,000 in early 2023, reverting to pre-Brexit levels. Projections published in April suggest it may decline further, potentially falling below 150,000 by mid-2026. Despite the sharp drop in net inflows, both the government and opposition support further reductions.

Government has called for tougher settlement rules for refugees and extended waiting periods for migrants who entered illegally, overstayed visas, or claimed benefits, with limited welfare available for permanent residents without citizenship. Assessing the impact isn’t straightforward, but political signals suggest that net inflows will remain subdued.

Our forecast projects net inflows averaging 140,000 annually from 2026 to 2030, which is significantly lower than the estimates provided by the ONS. A reduced number of arrivals will result in a contracting workforce.

Labor supply growth will slow considerably in years ahead

Fewer arrivals will be compounded by a shrinking native working age population. Currently, it is estimated that by mid-2026, 19.6% of the workforce is over 65. This is expected to climb to 21.1 % by 2030 and 24.9% by 2050. Increasing the state pension age encourages older workers to stay employed and helps. However, the implementation of changes is a complex process that necessitates comprehensive long-term planning and may result in substantial socio-economic impacts.

Growth in the labor supply is a direct input into GDP growth, alongside growth in capital formation.¹ Slowing supply will therefore have a direct impact on overall economic activity. We expect labor supply growth will contribute 0.4 percentage points annually to potential output from 2026–2030, down from the pre-pandemic average of 0.9 points per year. The problem gets bigger in the long term; for the period 2031-2050, we expect labor supply growth to add less than 0.1 percentage points annually to potential output.

Productivity struggles to grow

The one thing that can offset the negative impact on growth trends is stronger productivity. However, there is no evidence to suggest a pickup.

Indeed, since the early 2000s, UK productivity has experienced several major disruptions resulting in a sustained slowdown commonly referred to as the “productivity puzzle.”

Of these events, Brexit is likely to have the most enduring impact, as it has introduced structural frictions into the UK labor market and reduced effective labour supply. Output per hour has increased just 0.4% yearly since Q4 2019, well below previous episodes as seen in Figure 2, driven mainly by the slowdown in public sector productivity.

AI is seen as a possible source of productivity growth. However, it is an unpredictable variable. The UK has not yet witnessed substantial AI-driven productivity gains or major investments in digital tech compared to the US, and it trails in equipment manufacturing.² Although the data centre sector is expanding rapidly, concerns about adequate energy supplies persist. Overall, while AI could eventually lift productivity, meaningful improvements may take time to materialize.

Official forecasts look too optimistic

The combination of weaker population growth and persistently subdued productivity implies a materially softer medium term growth profile for the UK than is currently embedded in official forecasts. Based on our assumptions for labour supply and productivity, we expect annual potential output growth to average at 1.1% throughout the rest of the decade, compared to the OBR current central forecast of 1.3%. We hold a significantly more cautious view regarding the UK's long-term economic trajectory, projecting a markedly diminished outlook by 2050.³

Investment Implications

While this does not generate immediate monetary policy consequences, it alters the longer run investment backdrop by increasing the economy’s sensitivity to adverse shocks and by placing greater strain on public finances as the population ages.

For UK government bonds, slower trend growth would traditionally be associated with lower equilibrium real rates. However, the analysis points to an offsetting force: a deterioration in fiscal dynamics as population growth undershoots projections and potential output slows. With fiscal headroom already limited, even modest downward revisions to growth assumptions could translate into higher borrowing requirements. Over time, this risks pushing term premia higher, particularly at longer maturities, as investors demand compensation for greater debt sustainability uncertainty rather than viewing gilts purely through a low growth, low inflation lens. (Figure 3)

The interaction between monetary and fiscal policy is, therefore, likely to become more important over the medium term. Although the Bank of England is likely to continue to treat slower population growth as broadly neutral for inflation within its forecast horizon, weaker potential output implies a narrower margin for fiscal manoeuvre. This raises the risk that future fiscal policy becomes more pro-cyclical, increasing the burden on monetary policy during downturns and heightening the importance of policy credibility in anchoring market expectations.

In equities, slower labour force growth and weak productivity gains point to a challenging backdrop for domestically focused sectors whose revenues and margins are closely tied to UK demand conditions. An ageing population and constrained workforce expansion also limit the scope for broad-based earnings growth driven by volume rather than efficiency gains. By contrast, internationally exposed UK companies are likely to remain relatively insulated from these domestic supply side constraints, reinforcing a structural divergence within the equity market rather than implying a uniformly weaker outlook for UK listed assets.

For sterling, a more pessimistic medium-term growth outlook than that implied by official projections suggests gradual downside risks over time, particularly if fiscal pressures intensify. While the absence of near term monetary policy implications reduces the likelihood of abrupt currency adjustment, weaker potential growth and rising debt sensitivity increase the probability that the exchange rate becomes a channel through which the economy adjusts to less favorable fundamentals.

Overall, the dominant investment theme is a shift toward structural constraints rather than cyclical weakness. Slower population growth, subdued productivity and rising fiscal sensitivity imply higher medium-term risks around debt dynamics, term premia and relative asset class performance.

For investors, this argues for greater emphasis on fiscal sustainability, long-run growth assumptions and differentiation between domestically exposed and externally oriented UK assets, rather than reliance on a benign low growth equilibrium.