UK QUARTERLY ECONOMIC OUTLOOK | Q4 2025
Inflation
Autumn Budget measures will cut inflation in 2026
By avoiding a repeat of 2024’s inflationary Autumn Budget in 2025, the Chancellor’s latest measures will cut inflation by around 0.3ppts over 2026. However, underlying inflation will remain far stickier, meaning inflation will struggle to drop back to 2% anytime soon and will probably settle around 2.5% in the medium-term.
UK inflation to drop back in April
There’s a handful of reasons why inflation will remain above 3% throughout Q1 before dropping sharply in Q2. First, last year’s array of regulated price hikes and tax rises will fall out of the annual comparison in April. This should take inflation down from over 3% to 2.5%. Second, the Chancellor used the Budget to reduce inflation by cutting household electricity bills and freezing rail fares. What’s more, food inflation has probably peaked and should fall back sharply across 2026 − a welcome change from the 5%+ inflation households have been dealing with recently.
This all means inflation should then drop further in the second half of the year. We anticipate a low of 2.3% this summer, before a slight rebound towards the end of the year. However, underlying inflation will stay stickier than the headline figure suggests. Services inflation, which is more reflective of domestic price pressures, will hover above 3.5% throughout the year, supported by stubborn wage growth. Furthermore, the Chancellor’s inflation-reducing Budget will only cut inflation for a year and then boost inflation in the medium-term, assuming the phase out of the ‘temporary’ 5p fuel duty cut goes ahead.
Risks mean 2% inflation in the UK is unlikely this year
Household inflation expectations – and to a lesser extent firms’ – remain elevated, despite being over the recent inflation peak. This is an issue if households bargain for bigger pay rises to protect their real incomes. Equally, firms could be more aggressive in passing on price hikes to consumers if they expect to be facing increasing cost-pressures. This is the main reason we struggle to see inflation returning to target to anytime soon.
Yet, the risks around inflation have reduced in recent months. First, the labour market has continued to weaken, instead of stabilising as expected. More slack will help to bring pay growth down further because employees will struggle to bargain for bigger pay against a backdrop of weak labour demand.
Second, the households’ saving ratio also remains high. Our base case assumes that some of this will gradually unwind over this year. However, it’s not hard to imagine a scenario where apprehensive consumers choose to keep saving. This would drag on demand and allow inflationary pressures to ease quicker.
Overall, we expect inflation to average 2.7% in 2026, down from 3.4% in 2025, as Budget policies and slower wage growth help inflation to moderate. Looking further ahead, while inflation will gradually continue to trend down, we see little chance of inflation returning to 2% next year either. After years of above-target inflation, inflation expectations are structurally too high to return inflation to 2% and will instead stabilise around 2.5% in 2027.
