UK QUARTERLY ECONOMIC OUTLOOK | Q2 2025
Inflation
3.5% for the rest of the year
Headline inflation jumped to 3.5% in April after gradually easing over Q1. We forecast it will now stay at around 3.5% for the rest of the year. Admittedly, much of the recent acceleration in inflation is due to one-off events, such as tax rises and regulated price increases, which mean inflation should come back down towards 2.5% in early 2026. However, persistent inflationary pressures mean it is unlikely to return to the 2% target until 2027.
‘Awful April’ boosts prices
The jump in inflation from 2.6% in March to 3.5% in April captured headlines, but it was almost entirely driven by increases in regulated prices, like utilities, tax rises and the late Easter. Crucially, there was little evidence of firms passing through the total increase in employment costs that occurred in April.
Above 3% inflation here to stay
Looking ahead, our forecast is that headline inflation will trend up slightly over the summer to peak at 3.7% before returning to around 2.5% early next year.
Services inflation should initially drop back to between 4.5–5% from 5.4% currently as the erratic factors that boosted it in April unwind. But, strong wage growth will prevent services inflation from falling more rapidly as firms fight to maintain profit margins.
On the goods side of the economy, we expect inflation this quarter to head over 2% from April’s 1.6%, peaking close to 3% in September. However, on a trade-weighted basis, the pound is the strongest it’s been since the Brexit referendum. It has appreciated by 2% this year. If sustained, we think that could take 0.2ppts off the headline figure and offset much of the increase in goods price inflation.
Into 2026, the big regulated price increases that caused April’s jump will start to drop out of the annual comparison, which will drag inflation back down to around 2.5%.
That said, there are two big risks here
First, so far there is limited evidence that firms have passed on April's employment costs through prices. There’s clearly a risk that firms still intend to raise prices and will do so by drip-feeding them throughout the year. This would push inflation higher than we expect.
Second, if the economy is more resilient to trade shocks than we’ve assumed (see the Economic Outlook section), then it would allow firms to be more aggressive at passing on the rise in employment costs than we’ve assumed. It would also result in a continuation of the stubbornly high pay growth we have seen recently, which would eventually feed through into higher inflation. Indeed, this is a risk that Huw Pill, Bank of England chief economist, has recently highlighted.
Ultimately, we expect inflation to average around 3.5% for the rest of this year before dropping down to 2.7% in 2026 with inflation returning to target in 2027.
