Growth in the UK rebounded in Q1 as the economy recovered from a weak end to last year due to Budget induced uncertainty, which dampened activity. That means the economy had a bit more momentum than we thought going into the energy crisis. However, this growth is likely to be the last we see this year. A renewed bout of political uncertainty and surging energy prices, both of which have pushed up borrowing costs, will compound to bring growth to a standstill as real household incomes stagnate for the rest of the year.

UK economic growth in 2026 likely to be a disappointment again

The UK economy proved resilient in the first month of the Iran war, with March GDP beating expectations on both our estimate and consensus. Consumers appeared relatively unphased, with hospitality output rising 1.3%, arts and recreation surging 2.2%, and retail jumping 0.7%, capping a strong month for consumer-facing services. The economy grew 0.3% month-on-month (m/m) overall, above our estimate of +0.1% and the consensus of -0.1%. That said, some of this strength was temporary. Consumer loading up on fuel ahead of price rises will unwind in April, and the manufacturing surge of 1.2% reflected firms bringing activity forward to get ahead of potential supply shortages and higher prices.

Q1 growth of 0.6% confirms our view that the UK economy is following a consistent pattern, strong at the start of the year before petering out. This mirrors Q1 last year, and since 2022 Q1 growth has averaged 0.6% compared to just 0.1% in the final two quarters. The causes are twofold. Some likely reflects the ONS struggling to adjust for shifts in spending patterns, but some undoubtedly stems from the dampening effect of recent budgets on the timing of activity.

The balance of growth in Q1 still looked healthy despite potential seasonality and some front-running of activity as consumer spending jumped by 0.6% and business investment rose by 0.7%, which suggests that the real economy was rebounding from the malaise it was suffering at the end of last year. In fact, we estimate the real economy grew by a whopping 0.9% in Q1.

The strong start to the year nudges up the likelihood of rate hikes at the margin, with growth coming in above the Monetary Policy Committee’s (MPC) 0.5% forecast, but for economists, Q1 is already ancient history.

An inevitable return to stagflation

We doubt this momentum will continue. Higher energy prices and spiralling political uncertainty dampen activity from Q2 onwards, which the MPC will have to balance against rising inflation.

Granted, the growth outlook this year is still highly uncertain, but we have now reached a point where another bout of stagflation looks unavoidable for the UK. Surging fuel prices have already pushed up inflation and will eventually lead to some second-round effects. The Strait of Hormuz has been shut for two and half months and oil reserves are being ran down at a record pace according to the IEA. That risks energy prices surging even further if tankers do not start transiting the Strait in the coming weeks as supply shortages will bite harder.

The current rise in energy prices is already enough to cause real household disposable incomes (RHDI) to all but stagnate this year, which will mean another weak year for consumer-facing services. Additionally, the sharp rise in market interest rates, will hit capital intensive industries such as manufacturing hard and make many private sector construction projects unviable.

What’s more, the growing political drama around Keir Starmer’s leadership position looks increasingly likely to result in a messy prolonged leadership contest that will see Pandora’s box of potential tax rises hit the headlines, further raising uncertainty and damaging sentiment.

A silver lining?

The good news is that households are saving close to 10% of their incomes meaning there is scope for them to reduce saving to support consumption as they did in 2022. A large increase in energy prices would still result in a significant reduction in RHDI and a drop in discretionary spending.

Ultimately, we think growth will slow to around 0.7% this year, down from 1.4% in 2025. At the same time inflation will rise close to 4.0% later this year. That makes a tricky balancing act for the MPC. If the economic data continues to hold up better than expected then a rate hike in the summer looks likely, but if there is a sharp slow down a prolonged hold looks more likely. For now, we expect a prolonged hold, but the risks are tilted towards a hike.

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