UK Economic Outlook – December 2025: Cooling Inflation, Weak Growth

UK Economic Review – November 2025: Disinflation for the Wrong Reasons

Overview: A Low-Growth, Disinflationary UK

By the end of November 2025, the UK economy looked increasingly like a low-growth, disinflationary story. Inflation is finally easing, but not because demand is strong and productivity is booming. Instead, price pressures are cooling against a backdrop of weak consumer spending, fading services momentum, contracting industry, and a softening housing market.

Fiscal policy has turned tighter under Chancellor Rachel Reeves, who delivered a tax-heavy budget designed to restore market credibility. At the same time, the labour market is loosening, business investment remains subdued, and households are clearly under pressure.

Despite these domestic headwinds, sterling has held up relatively well, supported by a softer US dollar and a perception that the UK’s new fiscal stance is more credible than in recent years.

The big picture: inflation is falling, but so is growth, leaving the Bank of England (BoE) cautious and markets focused on when, not if, rate cuts will start in 2025.

Growth & Activity: An Economy at Stall Speed

Growth data confirm that the UK is technically expanding, but only just.

• Q3 GDP grew 0.1% quarter-on-quarter and 1.3% year-on-year, missing expectations and highlighting how fragile momentum has become.
• Monthly GDP for September fell 0.1%, while the three-month rolling measure was only 0.1%, a classic “stall-speed” profile.
• The Index of Services rose a modest 0.2%, indicating that even the UK’s traditional growth engine is losing steam.

Business surveys told the same story:

• The November composite PMI slipped to 50.5, barely in expansion.
• Services PMI fell sharply to 50.5, signalling a clear deceleration.
• Manufacturing PMI crept back above 50, but the underlying factory activity remained weak.
• The CBI Industrial Trends Orders balance stayed deeply negative, pointing to thin order books and soft demand at home and abroad.

Industrial and construction data reinforced the gloom: industrial and manufacturing output shrank on both monthly and annual bases, while construction PMIs in the mid-40s showed the sector firmly in contraction.

Bottom line: the UK is avoiding outright recession for now, but forward momentum in services, manufacturing, and construction is clearly fading.

Labour Market: From Tight to Loosening

The labour market is no longer the pillar of strength it was in earlier phases of the cycle.

• Unemployment edged up to 5.0%, from 4.8%.
• Employment fell on a three-month basis, reversing previous gains.
• The claimant count rose strongly, signalling more people turning to benefits.

Pay growth is moderating:

• Regular pay (ex-bonus) is running at about 4.6% year-on-year.
• Total pay has slowed to around 4.8%, from 5.0%.

This combination of rising unemployment, softer employment, higher claims, and easing wage growth suggests that the labour market is loosening in a controlled way, rather than collapsing.

There was a small positive: labour productivity ticked up in the latest quarter, helping to contain unit labour costs. But for now, that looks more like a welcome blip than a structural shift.

Consumers & Retail: Demand Fatigue on Full Display

The consumer sector was one of the softest spots in November.

Official retail sales data showed a broad-based pullback:

• Headline sales fell 1.1% month-on-month, far worse than expected, and annual growth slowed sharply.
• Core sales (excluding fuel) also dropped in the month and undershot expectations year-on-year.

This wasn’t a one-off driven by a specific category. It was a clear sign that households are tightening their belts under the weight of high borrowing costs, squeezed real incomes, and lingering cost-of-living pressures.

Surveys backed up that weakness:

• The CBI Distributive Trades Survey remained deeply negative, signalling falling sales volumes compared with a year earlier and growing pessimism among retailers.
• Car registrations saw a dramatic month-on-month drop after a previous spike, highlighting how fragile big-ticket demand has become.
• Consumer sentiment indices weakened, reflecting concerns over living costs, job security, and the broader economic outlook.

Conclusion: UK consumers are in slowdown mode, becoming more selective and cautious rather than ramping up spending into the year-end.

Inflation & Prices: Disinflation, Not Deflation

The good news in November was that disinflation is gathering pace.

Consumer prices:

• Headline CPI eased to around 3.6% year-on-year, with monthly gains consistent with a normal seasonal pattern.
• Core CPI slipped to roughly 3.4%, with the monthly reading slightly softer than expected, pointing to easing underlying pressures.

Producer prices told a similar story:

• Input prices were essentially flat over the year, highlighting very limited cost pressure for firms.
• Output and core output prices were stable, with no sign of renewed inflation momentum.

Retail price measures also cooled, with both headline and core gauges slipping further, even if monthly changes normalised after earlier drops.

Taken together, CPI, PPI, and RPI all point to a UK economy moving deeper into disinflation, not towards outright deflation. Prices are still rising, but at a slower pace, and monthly data are no longer flashing upside-down surprises.

For the BoE, this is powerful confirmation that the rate-hiking phase is over.

Housing & Credit: A Rate-Sensitive Drag

The housing market continues to absorb the shock of higher rates and tighter credit conditions.

• Asking prices on new listings have fallen in the month and are slightly lower than a year ago.
• Official house-price indices show slower annual gains, confirming a decelerating trend.
• Some private measures show small monthly increases, underscoring an uneven, regionally mixed picture rather than a uniform crash.

Mortgage rates remain high, in the high-6% area for typical products, keeping affordability stretched and transaction volumes relatively subdued.

Taken together with weak construction PMIs and only modest growth in construction output, housing is no longer a cushion for growth, but rather a drag.

Fiscal Position & Gilt Market: Tightening for Credibility

Public finances remain under pressure, with elevated borrowing and large cash deficits reflecting weak growth, high debt-servicing costs, and persistent spending demands.

Against this backdrop, Chancellor Reeves’ budget marked a clear strategic shift:

• Roughly £26 billion in tax increases were announced.
• The plan is designed to stabilise finances, fund spending commitments without another borrowing surge, and rebuild credibility after years of volatility.

In the short term, this is growth-negative: higher taxes weigh on households and businesses. But in the medium term, a credible consolidation can:

• Lower the risk premium on gilts,
• Support a more stable currency, and
• Reduce the probability of another funding shock.

Gilt auctions in November passed smoothly, with 10-year yields drifting lower and no signs of dysfunction, in sharp contrast to the turmoil of 2022. Investors appear willing to fund the UK at current yields, provided the fiscal strategy stays credible.

BoE Policy, Rates & Sterling: “Higher for Long, But Not Longer”

In November, the BoE kept Bank Rate at 4.0%. The narrow MPC vote split, with several members already favouring cuts, signalled:

1. The hiking cycle is finished.
2. Internal pressure to start easing in 2025 is building.

With weak retail and auto demand, a soft labour market, fragile housing, and a tightening fiscal stance, the BoE now faces a timing question: when to cut, not whether to hike again.

Sterling, meanwhile, has held up better than the domestic data might suggest:

• It traded in the low-to-mid $1.31–1.32 range during and after the budget.
• The pound was supported by a softer US dollar, lower gilt yields without funding stress, and an improved perception of UK fiscal management.

In effect, GBP is trading more like a “credible, high-carry” currency, backed more by global conditions and reduced tail risks than by strong domestic fundamentals.

Overall Assessment & Outlook

By late 2025, the UK will have become a low-growth, disinflationary economy with limited policy space:

• Growth is at stall speed.
• The labour market is loosening, not collapsing.
• Consumers are cautious and fatigued.
• Inflation is falling across the pipeline.
• Housing is soft and rate-sensitive.
• Fiscal policy is tightening to regain credibility.
• The BoE is on hold, with the next big move likely a cut in 2025.

The key macro risk is shifting from inflation staying too high to growth becoming too weak. Policymakers now face a delicate balancing act: easing monetary policy early enough to support activity, without undoing progress on inflation or unsettling markets about fiscal sustainability.

UK Economic Outlook — December 2025

Overview

As 2025 draws to a close, the UK economy is navigating a low-growth, disinflationary environment. Output is still expanding, but only modestly; inflation is easing from earlier peaks, yet remains above target; and the labour market is clearly softening. In this context, attention is shifting toward when the Bank of England will begin a clearer easing cycle in 2026, rather than whether more hikes are coming.

At the same time, fiscal policy has tightened slightly, and financial markets are already pricing in a path of gradual rate cuts, lower gilt yields, and only moderate upside for UK equities.

Growth Outlook: Modest Expansion, Weaker 2026

Economic growth in 2025 is projected at around 1.5%, supported by continued government spending and stronger momentum in the first half of the year. This has been enough to keep the economy out of recession, but not enough to generate a convincing acceleration in activity.

Looking ahead to 2026, most forecasters expect growth to weaken, with projections in a relatively low range of 0.9% to 1.4%. This softer profile reflects:

• Tighter fiscal policy, as tax increases and consolidation weigh on demand
• Subdued global conditions, which limit export growth and business investment

Forward-looking indicators point to slower business activity and waning consumer demand, reinforcing the view that the UK is likely to experience a gentle but persistent slowdown rather than robust expansion.

Inflation: Past the Peak, Still Above Target

Inflation has clearly moved past its peak but remains above the 2% target.

• Consumer price inflation (CPI) is expected to average around 3.5% in 2025, after reaching roughly 3.8% in September.
• In October, CPI eased further to 3.6%, continuing the disinflation trend.

Both official and private-sector forecasts point to a gradual decline toward the 2% target by mid-2027, supported by:

• Base effects from earlier price spikes
• Normalising energy prices
• The lagged impact of restrictive monetary policy

In 2026, inflation is expected to fall to roughly 2.5%, but services inflation remains a concern, as wage-sensitive and domestic components of prices are typically slower to adjust.

Labour Market: From Tight to Softening

The labour market has weakened noticeably over the course of 2025.

• Unemployment has averaged around 4.8% this year.
• Data for July–September show unemployment rising to 5.0%, equivalent to 1.79 million people out of work.

Other indicators confirm a loosening backdrop:

• Vacancies have been falling steadily, indicating less hiring appetite.
• Payrolled employment has softened, pointing to slower job creation.
• Wage growth has begun to cool, even as inflation eases.

Although real wages are now improving because price growth is slowing, hiring intentions across sectors have moderated. As a result, unemployment is projected to edge up to around 4.9% in 2026, suggesting a transition from a tight labour market to a more balanced, but softer, one.

Monetary Policy: A Turning Point for the Bank of England

Monetary policy is now clearly at an inflection point.

The Bank of England (BoE) kept the Bank Rate at 4% in early November, following an earlier 25-basis-point cut in August and two consecutive meetings on hold. However, markets and analysts widely expect:

• A further 25-basis-point cut to 3.75% at the 18 December meeting
• A gradual easing cycle through 2026, potentially taking Bank Rate to around 3.25% by year-end

The future path of rates will depend on:

• The pace of disinflation – especially how quickly headline and core CPI move toward 2%
• Labour-market developments – particularly unemployment trends, wage growth, and hiring conditions

In short, the BoE has moved from a “how high?” mindset to a “how long and how fast to cut?” discussion, with 2026 likely to be defined by measured reductions in policy rates.

Fiscal Landscape: Gradual Consolidation, High Debt

The fiscal backdrop has shifted modestly following the Autumn Budget.

• Public borrowing is projected to fall from 4.5% of GDP in 2025–26 to 1.9% by 2030–31, helped by revenue-raising measures and a more cautious spending stance.

However, elevated inflation and higher debt-servicing costs continue to push up the debt ratio, which is expected to remain near 83% of GDP. This means:

• The government has less room for large-scale fiscal stimulus, especially if growth disappoints.
• Fiscal policy is likely to remain a moderate drag on growth while supporting long-term credibility.

Structural indicators such as employment levels and real wages confirm a labour market moving from tight to more balanced conditions, reinforcing the view that the economy is cooling gradually rather than abruptly.

Key December 2025 Events to Watch

Several high-profile data releases and policy decisions in December 2025 will be critical for shaping the near-term outlook:

• 16 December – Labour-market data
• Updated figures on employment, unemployment, and wages will show whether labour-market slack is continuing to build.
• 17 December – Inflation data
• CPI and related measures will help confirm whether disinflation is progressing in line with expectations.
• 18 December – MPC policy decision
• The Bank of England is widely expected to cut Bank Rate by 25 bps to 3.75%, marking another step in the transition from tight to less restrictive policy.
• 22 December – Q4 GDP estimate
• The first estimate of Q4 2025 GDP will offer a clearer sense of whether the UK is experiencing a gentle slowdown or a more pronounced deceleration.

Together, these events will play a major role in how markets, businesses, and households perceive the trajectory for 2026.

Financial Markets: Rate-Cut Expectations in the Driver’s Seat

Gilts and Interest-Rate Markets

In bond markets, rate-cut expectations dominate sentiment.

• Gilt yields have declined to around 4.45%.
• Analysts expect yields to stabilise near 4.2% next year, assuming a smooth, gradual easing cycle and no major fiscal or external shocks.

Lower yields reflect both the disinflation trend and growing conviction that policy rates will be lower in 2026 than in 2025.

Sterling

Sterling remains vulnerable after a nearly 9% decline in 2024.

• Expectations of further BoE rate cuts could put additional pressure on the currency.
• At the same time, greater fiscal credibility and lower tail-risk compared with previous years offer some support.

Overall, the pound is likely to be sensitive to interest-rate differentials, risk appetite, and incoming UK macro data, especially on growth and inflation.

Equity Markets

Equity markets are cautiously constructive:

• The FTSE 100 stands to benefit from:
• Low valuations relative to some global peers
• Significant overseas earnings exposure, which can be supported by a weaker pound
• Strong dividend yields, which remain a key attraction for income-focused investors

However, upside is expected to be moderate, constrained by:

• Subdued domestic growth
• The global risk environment
• Ongoing uncertainty around the pace of disinflation and policy easing