UK QUARTERLY ECONOMIC OUTLOOK | Q3 2025
Inflation
Inflation to peak at 4% this year
UK inflation rose to 3.8% in July and is set to remain over 3.5% for the rest of 2025. The initial jump in inflation back in April was down to a swathe of regulated price increases and tax hikes. However, since then, inflation has gradually nudged higher off the back of rising food prices and will peak at 4% later this year, which could prompt households to bargain for bigger pay rises.
We expect inflation to fall back below 3% in April 2026 as one-off regulated price hikes drop out of the annual comparisons. The risk is that another round of tax hikes next April will prevent this. Ultimately, persistent inflationary pressures mean we don’t expect UK inflation to fall back to target anytime soon.
Cost of essentials to push inflation to 4%
We expect inflation to peak at 4% in September, up from our forecast of 3.7% in our Q2 Outlook, before easing to just under 3% in April next year.
Rising inflation will be driven by two key factors. First, food prices have surged recently. They’ll continue to head higher over the rest of the year, thanks to rising agricultural commodity prices. There‘s also some evidence that supermarkets and food producers, which were particularly hard-hit by the rise in employment costs in the last Autumn Budget, are passing on these costs to consumers. We expect food inflation to reach 5.5-6% by the end of the year.
Second, fuel inflation rose strongly in July and will continue to do so over the coming months. Admittedly, this is largely due to a base effect; fuel prices were falling sharply this time last year, which will push up the annual measure of fuel inflation.
Turning to services inflation, which remains stubborn at 5%, we expect it to remain around 4.5–5% for the rest of this year because higher regulated prices will keep inflation elevated. However, the bigger story is one of gradual disinflation. Wage growth is currently too high to return inflation to 2%, but slowing steadily. This should eventually feed through into smaller price increases in the services sector by the middle of next year.
Why is UK inflation stubbornly high?
All told, inflation will remain well above target for the next couple of years. We see three reasons for this.
First, there is a risk that the Chancellor raises duties by more than we expect to fill another fiscal hole. We think of most taxes as being deflationary because they reduce demand in the economy. Duties, however, are stagflationary. They not only dampen demand, but also increase the cost of the goods they are levied on. This could prevent inflation falling back below 3% in April.
Second, we think there’s a risk that inflation expectations, which are already elevated, continue to rise due to increasing food prices, which could prompt households to bargain for bigger pay rises to protect their real incomes. Firms could also be more aggressive in passing on price increases to maintain their margins.
Third, UK economic growth has averaged 0.5% per quarter so far this year, despite the headwinds from taxes and tariffs. This rate is around the UK’s economic speed limit, so any continued strong growth could be inflationary as firms find it easier to pass on price increases.
Ultimately, we expect inflation to average 3.8% for the rest of this year, before averaging 2.9% in 2026, but the risks are to the upside as the Monetary Policy Committee (MPC) wrestles with persistently above-target inflation.
