UK Economic Outlook 2026 and Overall 2025 British Economic Review

UK Economic Review 2025: Disinflation Arrived, Growth Didn’t

In 2025, the UK faced an awkward mix of cooling inflation and weak activity. Bond markets became sensitive to the country’s low‑growth profile—yields rose amid sticky inflation, a lacklustre trend growth of about 1% per year and limited fiscal flexibility. Household demand remained fragile: GDP in November 2024 rose just 0.1% month‑on‑month, while December retail sales fell 0.3%, highlighting how quickly consumers pulled back as real incomes were squeezed. Against this backdrop, the Bank of England needed disinflation to spread into services, yet the economy was operating close to stall speed.

Early 2025: soft growth, easing inflation, tighter fiscal tone

Data early in the year suggested the UK was avoiding a hard downturn but lacked lift. Fourth‑quarter 2024 GDP grew only 0.1% quarter‑on‑quarter (1.4% year‑on‑year), and January 2025 retail sales declined 0.5%, underscoring cautious consumers. Inflation rose to 3.0% in January from 2.5% in December 2024—still uncomfortable for policymakers seeking to declare victory. Fiscal policy took a credibility‑first stance: Chancellor Rachel Reeves’ package included major revenue measures—most notably a rise in employers’ National Insurance Contributions to 15% from April 2025 with a lower threshold—reinforcing the view that policy would remain restrictive even as growth cooled.

The first pivot: cautious monetary easing begins

The Bank of England’s easing cycle started cautiously. In May 2025, the Monetary Policy Committee (MPC) cut Bank Rate by 25 bp to 4.25% (by a 5–4 vote), with internal disagreement showing how concerned policymakers were about persistent domestic inflation and the risk of renewed price pressures later in the year. The signal was clear: easing was possible but would be incremental and data‑dependent.

Mid‑year reality check: stagnation signals emerge

By June, the economy seemed trapped between disinflation and stagnation:

• Consumers deteriorated sharply: retail sales registered their worst month in more than two years (core sales down 2.8% month‑on‑month), while survey sentiment weakened.
• Housing sent mixed signals, but credit tightened: mortgage approvals came in below expectations and net mortgage lending turned negative, consistent with high interest rates still weighing on demand.
• Labour‑market pressures became visible: earnings growth slowed, the claimant count jumped, and unemployment edged up to 4.6%.
• Inflation moderated but remained high: CPI eased to 3.4% year‑on‑year, with core CPI at 3.5%—progress, but still not mission accomplished.

By July, labour‑market slack intensified: unemployment rose to 4.7%, vacancies kept falling, and payrolled employees declined, even as wage growth stayed high enough to keep services inflation sticky.

Summer: rate cuts continue amid inflation surprises

In August, the BoE delivered another 25 bp cut, taking Bank Rate to 4.0%—again by a narrow 5–4 margin, reinforcing the “measured steps” approach. Yet inflation was not cooperating; headline CPI rose to 3.8% in July, while services inflation stayed elevated at 5.0%, preventing a more aggressive easing cycle.

Late summer to early autumn: services hold up, industry stays weak

The economy’s internal split became clearer:

• Q2 GDP grew 0.3% quarter‑on‑quarter (1.2% year‑on‑year), buoyed by services and a rebound in construction.
• Surveys improved but unevenly: the August flash composite PMI rose to 53.0, driven by services (53.6), while manufacturing remained in contraction (47.3).
• September reinforced the two‑track economy: services PMIs (54.2) and composite PMI (53.5) stayed firm, but industrial output fell, and trade deficits remained a structural drag.

This period encapsulated the core 2025 dynamic: services resilience averted a recession, yet the goods‑producing sector and external balance constrained overall growth.

Year‑end: “disinflation for the wrong reasons,” then another cut

By November, the macro narrative had hardened into low growth with falling inflation—less a soft landing than stagnation with disinflation. Third‑quarter GDP grew only 0.1% quarter‑on‑quarter (1.3% year‑on‑year), monthly GDP fell 0.1%, and PMI readings hovered near the expansion/contraction line (composite 50.5; services 50.5). In December, disinflation progressed enough for the BoE to cut again: Bank Rate was reduced from 4.00% to 3.75% (5–4 vote). PMIs remained expansionary (composite 52.1), but the overarching message was still one of low‑growth drift, with activity weak and uneven and consumers restrained.

Final summary: The UK entered 2025 with fragile growth and fading—but still elevated—inflation, and ended the year with clearer disinflation but even weaker momentum. Rate cuts arrived gradually and with split votes, as services inflation and wages kept the MPC cautious. Throughout the year, the economy avoided a full‑blown recession thanks largely to services but remained held back by tight financial conditions, subdued consumer spending, a softening labour market and persistent structural headwinds in industry and trade.

UK Economic and Market Outlook 2026

Macroeconomic projections and policy expectations

Major institutions broadly expect the UK to see modest growth in 2026 alongside continued disinflation. The BoE and Office for Budget Responsibility project real GDP growth of about 1.2–1.5% after a sluggish 2025. The IMF forecasts roughly 1.3% growth, while the OECD sees around 1.2%. This subdued expansion reflects lingering high interest rates, weak productivity and cautious consumers recovering from a severe cost‑of‑living squeeze. The UK likely narrowly avoided recession in 2025 and enters 2026 with “low‑growth drift” momentum. High borrowing costs and a soft housing market have restrained demand, though easing inflation and expected rate cuts later in 2026 could gradually improve conditions. Unemployment, which reached around 5.1% by late 2025, is expected to hover near 5.0% through 2026 before gently declining. In short, the baseline for 2026 is sub‑trend growth and a soft labour market—but not a deep downturn.

Inflation outlook

After peaking above 10% in 2022, headline CPI fell to about 3.8% by late 2025. Forecasters expect inflation to continue cooling and approach the target by end‑2026. The OBR and BoE project CPI of roughly 2.5% by Q4 2026, on track to hit the 2% goal in 2027. The IMF sees UK inflation averaging 2.5% in 2026, still the highest in the G7, but markedly lower than recent levels. Fiscal measures in the new budget (e.g. energy bill subsidies) should help bring headline CPI near 2% by mid‑2026. However, risks remain: domestic cost pressures—wages and service prices—were stickier than expected in 2025, leading the OBR to raise its 2026 CPI forecast to 2.5% (0.4 percentage points higher than previously assumed). Policymakers will be monitoring any renewed price pressures. Overall, economists expect a normalisation of inflation across rich countries in 2026, which should allow interest rates to decline and lift a constraint on growth.

BoE and monetary policy

After aggressive hikes in 2022‑23, the BoE paused in 2024 and delivered its first cut in late 2025, lowering Bank Rate from 4.00% to 3.75% in December. This signalled a cautious pivot as inflation pressures eased. Markets and BoE guidance suggest gradual further cuts through 2026. The market‑implied path has Bank Rate drifting toward 3.5% by the second half of 2026, with some analysts expecting around 3.25% by year‑end. The OBR notes that the yield curve implies Bank Rate at about 3.6% by end‑2026, and BoE commentary points to a gradual downward path if disinflation proceeds as hoped. Easing will remain data‑dependent: if inflation persistence is stronger, the Bank may slow or pause cuts (or even hike again); if demand weakens more, deeper cuts could be needed. For now, the baseline is a gentle easing cycle that takes policy from a restrictive ~5% peak in 2024 down toward neutral (~3%–3.25%) by late 2026. Long‑term gilt yields are expected to stabilise in the mid‑4% range, barring fiscal or global shocks.

Government and fiscal policy: the main risk

Fiscal policy in 2026 will reflect the choices of the new government elected in 2024. The Autumn 2025 budget, under Chancellor Rachel Reeves, enacted tax rises and spending restraint to rebuild fiscal buffers. This tighter stance—equivalent to roughly 0.5–1.0% of GDP consolidation in 2026—will slightly dampen growth but remove risk premium from UK markets. Bond investors welcomed the increased fiscal headroom of over £21 billion. Assuming no major U‑turns, fiscal policy will be a mild headwind to demand yet supportive of credibility. A wildcard is politics: with local elections in May and government popularity waning, some worry fiscal discipline could falter. An unpopular government might loosen the purse strings to spur growth ahead of an expected 2027 general election, risking higher yields or a weaker pound as the UK remains reliant on foreign investors to finance its debt. Barring such a scenario, the fiscal backdrop for 2026 is one of consolidation: the OBR forecasts public borrowing trending down from about 4.5% of GDP in FY25/26 toward 3% by FY27/28. Government bond issuance is likely past its peak and skewed toward shorter maturities; combined with BoE cuts and a credible budget, gilt markets should remain stable and potentially outperform in 2026.

Key Sector Insights: Housing, Finance and Energy

Housing market

The UK housing market appears poised for a steadier 2026 after the mortgage‑rate shock of 2023–24 cooled prices and activity. With borrowing costs expected to ease, most major forecasters anticipate modest price growth of roughly +2% to +4% by end‑2026—more stabilisation than boom. Regional divergence should persist: more affordable areas (Scotland, Wales and northern England) may outperform, while London and the South East could lag. Affordability is likely to improve gradually as rates fall and wages rise, with wage growth expected to outpace house prices and help first‑time buyers in real terms. Transaction volumes could recover from depressed 2025 levels as delayed movers return, although the outlook remains sensitive to the pace of disinflation and rate cuts.

Financial services (banks and the City)

UK banks enter 2026 in a relatively strong position after benefiting from higher rates. Many have structural hedge portfolios that can support net interest margins even as the BoE cuts. Solid capital buffers and generally stable credit conditions underpin resilience, and the sector remains attractive to investors for dividends and buybacks. The main risk is late‑cycle deterioration: if growth stays weak and unemployment rises, impairments could increase. For the City of London, competitiveness initiatives and post‑Brexit adaptation will continue, while investment banking could improve if global issuance and M&A recover. Private credit is growing, but credit‑quality concerns warrant monitoring.

Energy

The energy sector in 2026 combines near‑term consumer relief with long‑term investment intensity. Household bills are far below their 2022 peaks, and forward pricing suggests energy is less of an inflation threat—though volatility persists within the price‑cap adjustments. At the same time, the UK’s energy transition is accelerating: offshore wind build‑out is regaining momentum, battery storage is scaling rapidly, grid upgrades are expanding, and nuclear projects (including large builds and early SMR progress) remain central. Key watchpoints include execution constraints—skills shortages, supply‑chain challenges and financing. Traditional energy earnings will hinge on global oil and gas prices, while renewables and utilities face large opportunities alongside execution risks.

Bottom line: Housing points to stabilisation with small gains, finance to continued profitability with credit risks to watch, and energy to lower inflation pressure alongside historically large transition investment.

British Pound Outlook (GBP in 2026)

After a volatile few years, the British pound enters 2026 on a relatively firm footing, having strengthened through 2025. Against the US dollar, sterling posted a strong year in 2025, rising into the mid‑$1.30s. Looking ahead, interest‑rate differentials and relative growth/inflation will be key drivers. The baseline sees mild GBP appreciation versus the dollar, but some softening against the euro.

Key drivers and risks

A major swing factor will be domestic policy credibility. Any sign of fiscal slippage or political instability—such as an early election or policy reversals—could hurt investor sentiment. RBC Wealth warns that if the government abandons fiscal discipline to boost its popularity, financial markets would likely turn jittery and punish the pound and gilts. The UK’s twin deficits (budget and current account) make it reliant on capital inflows, so sterling is sensitive to any “sell UK” mood. Conversely, a smoother global backdrop, especially a stable Eurozone, would support the pound by reducing risk premia. Inflation differentials matter too: if UK inflation proves stickier than elsewhere, the BoE might keep rates higher for longer, paradoxically supporting GBP in the short run via carry—yet persistent inflation could erode confidence. In a stagflation scenario, where UK prices stay high and growth stalls, the pound could suffer notably, as investors would demand a higher risk premium for UK assets. Brexit‑related issues have been quieter but remain an underlying consideration (EU‑UK trade frictions continue to contribute to weak trade data). Overall, the baseline anticipates no return to extremes—neither the record lows near $1.07 in 2022 nor rallies to the $1.50+ pre‑Brexit levels. Rather, sterling is expected to be range‑bound to slightly firmer versus USD and a tad softer versus EUR, reflecting middling economic prospects in 2026.

GBP/USD (cable)

The baseline view is range‑bound to mildly stronger, with forecasts clustering in the $1.30–$1.40 zone. The common narrative is that the Federal Reserve is expected to cut more aggressively than the BoE, narrowing the dollar’s yield advantage and keeping a modest upward bias for GBP. Upside is limited because sterling would already be fairly strong versus recent years, and the BoE is still expected to cut (albeit less than the Fed). GBP also remains risk‑sensitive—performing better in “risk‑on” markets and sliding if safe‑haven USD demand returns.

GBP/EUR

Consensus tilts towards a slightly softer pound versus the euro, with several forecasts pointing to EUR/GBP drifting toward ~0.90 (roughly GBP/EUR ~1.11). Reasons include:

1. Policy divergence: the BoE is cutting more while the ECB approaches its trough.
2. Fiscal/growth differentials: the euro‑area has more fiscal support, whereas the UK is tightening.
3. Valuation: sterling is no longer cheap after its recovery.

Stock Market Outlook: FTSE 100 and UK Equities in 2026

The FTSE 100 pushed above 10,000 in early 2026, helped by its heavy exposure to commodities and banks. Record or near‑record industrial‑metal prices lifted major miners, while firm oil prices and geopolitical risk premia supported energy names. UK bank stocks also rallied as higher yields and a steeper curve improved net interest margins, alongside generally resilient earnings and balance sheets. With inflation easing, sentiment improved, and the index reached fresh highs.

After a stronger‑than‑expected 2025, the 2026 outlook remains constructive, though performance may diverge between large‑cap multinationals/exporters (which dominate the FTSE 100) and domestically oriented UK stocks. Valuation is a key tailwind: even after the rally, UK equities still trade at a discount to many global peers—about 12.5× forward earnings for the FTSE All‑Share, per RBC—leaving scope for additional upside if investor positioning normalises. High‑dividend sectors such as consumer staples, healthcare and utilities, along with other defensives, remain attractive as income plays and partial inflation hedges. Sterling’s relative stability in the mid‑$1.30s also supports confidence without materially eroding exporters’ earnings.

Overall, the UK equity outlook for 2026 is positive but not without caveats. The baseline calls for respectable gains, potentially outperforming bonds and some overseas markets as inflation cools and rate cuts begin. The FTSE 100 should remain supported by its globally exposed heavyweights—energy, mining, banks and pharmaceuticals—while the more domestically sensitive FTSE 250 could outperform if UK growth and consumer conditions improve. With UK shares still inexpensive by global standards, only a modest shift in sentiment may be needed for international investors to increase allocations to London. Even as the OBR trims growth forecasts, many market participants appear focused less on near‑term GDP and more on improving macro stability. In the absence of a major negative shock, sentiment toward UK equities is likely to stay firmer than during the turbulence of 2022‑23.