The UK economy beat expectations again in August, adding to evidence that growth has genuine momentum despite the squeeze on household incomes from higher energy prices. As a result, Q3 growth now looks set to come in at around 0.6%, even if there is some payback in September. However, we still expect growth to slow in Q4 and remain subdued in early 2027 as higher energy prices push inflation back above 4% and weigh on real incomes. In turn, the combination of firmer growth and higher inflation is likely to prompt the Bank of England to raise interest rates in November and once more next year.

UK GDP continues to surprise to the upside

The UK economy grew by 0.1% in August, above the consensus estimate for a 0.1% contraction.

The main driver of the upside surprise was the retail and wholesale sector, which contributed 0.19 percentage points to GDP growth. Most of this came from wholesalers, where activity rebounded after a weak summer. By contrast, consumers had a softer month, with consumer-facing services falling by 0.3% amid sharp declines in hospitality and arts and recreation.

Elsewhere, rising manufacturing production looks to be far more than a temporary boost from front-running potential supply shortages and higher energy prices with output jumping by another 1.2%.

Professional services activity jumped by 1.5%, contributing 0.14 percentage points to GDP growth, although this was offset by declines in IT and administrative services. More importantly, these sectors have grown by an average of 0.8% per month since the conflict in Iran began, up from just 0.1% in 2025. That sharp pickup has been a key driver of the UK's stronger-than-expected growth this year.

Overall, the economy continued to outperform expectations despite the energy shock. Growth now looks likely to reach around 0.6% in Q3, even if activity cools slightly in September. If that materialises, 2026 will increasingly look like a year of respectable growth rather than one defined solely by resilience, even if the economy does little more than stagnate in Q4.

Hotter economy makes rate hikes more likely

For the Bank of England, the broad-based strength of the economy carries two important implications. First, interest rates may not be as restrictive as policymakers had previously assumed. Second, stronger demand increases the likelihood that firms can pass higher energy costs on to consumers, creating more persistent second-round inflation effects. Taken together, this suggests that interest rates need to go higher to lean against the risk of inflation becoming embedded. With inflation now likely to peak at around 4.5% early next year, we expect the Bank to raise rates twice, beginning in November.

That said, we still expect growth to slow in Q4. Much of the inflationary hit from the conflict in Iran is still in the post. Inflation will jump from 3.1% currently to 4.5% in early 2027, as utility bills reset higher. Combined with subdued wage growth, that will intensify the squeeze on real household incomes, prompting consumer spending growth to slow.

That will only increase the pressure on Chancellor Healey to take more action on the cost of living at the Budget. However, with fiscal headroom significantly reduced and financial markets closely scrutinising the public finances, the scope for broad-based support appears limited. Moreover, sizeable commitments on defence and social care spending will eventually need to be funded, leaving little room for a major fiscal intervention.

Ultimately, the economy has weathered the initial energy shock far better than expected, but rising inflation, a weak labour market and persistent uncertainty mean the risks remain skewed towards a slowdown in Q4. That will increase pressure on John Healey to find ways to support households, but the tight fiscal position may limit how much the Chancellor can do.

Related insights