The UK economy finished last year on a pretty soft footing as speculation around November’s Budget took its toll. Some of that weakness should unwind at the start of this year – our new UK Economic Outlook 2026 includes full year-ahead forecasts for growth, interest rates, inflation, the labour market and performance relative to the US and Europe – but there are still six big questions that’ll define the UK economy and its prospects for this year.

What impact will geopolitics have on the UK economy?

Geopolitics was a huge driver of the narrative last year. US tariffs and events in the Middle East prompted wild swings in equity and commodity markets, even though the direct economic consequences ended up being smaller than expected. This year has already started off at a frantic pace on the geopolitical front, suggesting geopolitics remains a major risk to the economic outlook. Indeed, there are three obvious areas of concern.

First, what’ll be the impact on energy prices of events in the Middle East or Ukraine? The price of a barrel of Brent crude for example has already risen by 10% this year. The good news is that oil prices should fall back as long as the actual supply of oil isn’t disrupted. That said, energy price movements will have a big impact on the UK inflation outlook, interest rates and consumer spending.

Second, how will changing international relations and US tariffs impact the UK? President Trump’s threat to impose tariffs on Denmark, Norway, Sweden, France, Germany, the Netherlands, Finland and the UK over Greenland has put the tariff threat firmly back on top of the agenda. It’s still the case that the direct impact of US tariffs on UK goods exports is minor, but the risk of a global trade war or other retaliatory actions from the EU has risen sharply this year. That could have a much bigger impact on the UK economy than the previous round of tariffs.

Third, will the Brexit deal be revisited? The government has made clear that improving the Brexit deal is a priority, but it’s easier said than done. The EU has said closer alignment will require the UK to follow more of the EU’s rules, which is politically dangerous. Rejoining the bloc in full looks very unlikely as it would both reverse the referendum result and require the UK to accept freedom of movement. We think the government will continue to seek incremental adjustments to the existing agreement. Such changes could boost the economy at the margin, but they're unlikely to be transformative for the UK’s medium-term outlook.

Will Sir Keir Starmer and Rachel Reeves survive the year politically?

Betting markets have a slightly greater than 50% chance that Sir Keir Starmer will be replaced as prime minister this year. The local elections on 7 May are likely to be the point of maximum pressure. A change of prime minister would almost certainly be accompanied by a change in chancellor. The key question then would be what the new approach to fiscal policy would be. More borrowing would potentially cause a rebound in gilt yields and put further interest-rate cuts at risk. More spending funded by higher taxes would fuel another cycle of worries about which taxes would be going up, sapping business and consumer confidence.

Can we expect more tax rises in the 2026 Autumn Budget?

The last two years have seen big tax-raising Budgets. With the public finances now on a firmer foundation, the move to one fiscal event a year and Chancellor Reeves more than doubling her headroom in the last Budget, there should, in theory at least, be no need for further tax increases − even if there’s some further deterioration in the economic forecasts.

However, as we saw last year, even the threat of imminent tax rises can do significant damage to the economy because households and businesses postpone activity. If the government hints that more taxes are coming in the Autumn Budget, then we can expect a repeat of the sharp slowdown in growth we saw in 2024 and 2025. Alternatively, if the Treasury makes it clear the next Budget will not raise taxes, then we should see business and consumer confidence gradually improve as inflation and interest rates come down.

Will UK inflation finally return to 2%?

This is one area of the economy where there should almost certainly be some good news this year after inflation jumped in 2025. Inflation will take a step down in April as the impact of price rises last year drop out of the annual comparison. It should then take another step down in the summer to only a fraction above 2% as policies announced at the 2025 Budget take effect.

The big question is what will happen in the second half of the year. A scheduled increase in fuel duty along with stubborn wage growth could push inflation back to almost 3%. Yet, a more benign scenario with lower energy prices and lower wage growth would see inflation at 2% by the end of the year.

How far will the BoE cut interest rates in 2026?

The Bank of England (BoE) cut interest rates four times last year, from 4.75% to 3.75%. However, at its last meeting the Monetary Policy Committee (MPC) said “judgements around further policy easing will become a closer call”. That’s because the BoE is getting worried that interest rates are approaching the point where they’ll stop bearing down on inflation. With the outlook for price growth cloudy this year, this caution is warranted.

Financial markets are factoring in two cuts this year. A move next month seems out of the question, but we could get another cut in April and then another in the second half of the year, but that depends on the benign inflation scenario winning out. Further cuts, down to 3%, would require the weakness in the labour market and demand to persist through the whole of this year. That, in turn, will largely depend on whether consumers start spending.

Will consumers finally start spending again?

The biggest single determinant of how the UK economy performs this year will be whether consumers save a little less and spend a little more. One unusual economic trend over the past two years has been that despite households’ real incomes rising by about 6%, consumption has risen by just 1%. Consumers’ reluctance to spend has been a significant factor in holding back growth given consumption makes up about two-thirds of the UK economy.

Unfortunately, that strong real-income growth is set to fizzle out this year as a weaker labour market, slower wage growth and inflation drag. The good news is households’ balance sheets are in a strong position and the saving rate is still far above pre-Covid levels, meaning there’s plenty of room for households to save less if they wanted to.

The answer to this question depends on whether consumer confidence improves, or if another round of political and economic factors will keep it subdued.

All things considered − and all things being equal − we expect moderate UK economic growth of around 1%, with a stronger outlook for 2027.

We expect Tuesday’s labour market data to show a continued cooling across the final months of last year.

The still-unreliable headline unemployment rate should tick down to 5% in November from 5.1%. That would be despite continued weakening in the jobs market because August’s erratic single-month figure drops out of the three-month average. The more timely payrolls data for December is likely to show another drop in employee headcount, probably by around 20,000.

Tuesday’s data is also probably going to show pay pressures continuing to ease. Whole-economy pay growth looks set to slow to 4.6% from 4.7%, while private-sector earnings, excluding bonuses, take a bigger drop to 3.7% from 3.9%. That’s still comfortably above 3%, which is what the Monetary Policy Committee (MPC) thinks is consistent with 2% inflation. This will ensure it remains cautious when it comes to further interest-rate cuts.

Looking ahead, we think the unemployment rate should stabilise in the coming months, then gradually tick down as hiring picks up as we leave the worst of last year’s big rise in employment costs behind us. That said, there’s a risk that weakening in the jobs market persists. In that case, we think the MPC would need to cut interest rates by more than the single cut we currently expect.

We expect inflation to tick up to 3.3% in December from 3.2%.

Higher tobacco inflation will be the main driver behind December’s rise. That’s because the extra tobacco duty from the recent Autumn Budget at the end of November was applied a month later than it was in 2024. This will push up the annual rate of tobacco inflation to 6.4% from its brief spell at 4.2% and contribute around 4bps to the rise in headline inflation.

What’s more, airfares inflation, which is particularly volatile, should surge from 0.3% to around 5%. This is likely to boost services inflation to 4.5% from 4.4%.

Ultimately, inflation is set to remain above 3% until April, when we expect inflation to fall to below 2.5% as last year’s array of regulated price increases and tax hikes drop out of the annual comparison. This will be further helped by the Chancellor’s recent decision in the Autumn Budget to freeze rail fares and cut the typical household’s electricity bill by £150.

December’s retail sales figures are likely to show a small drop in the lead-up to Christmas.

Both the BRC measure of retail sales, which we adjust for inflation, and the Barclays Consumer Spend Report suggest a slowdown in annual retail sales growth. A similar move in the official data would be consistent with a small drop in retail sales of around 0.4% on the month.

Admittedly, retail sales are volatile and have already fallen for two consecutive months, so there’s a good chance of a bounce in December as spending that was put off ahead of the Autumn Budget takes place. That would be further backed up by the slight improvement we saw in consumer confidence after Budget uncertainty had dissipated.

Ultimately, we think there's more uncertainty than usual when it comes to the upcoming retail sales data given the mixed signals in leading indicators. We err on the downside and anticipate a small drop in retail sales. In any case, retail sales will rise in Q1 as postponed activity from the end of 2025 happens and consumers start to feel a little more confident.

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