UK Economic Outlook 2026

One goal behind, but UK economy still in the match

Our summer outlook probably isn’t as bad as England’s chances of winning the World Cup this summer, but it still doesn’t make for the most pleasant reading. The Iran conflict has pushed up our inflation forecast, weighing on growth and the labour market. Domestic political uncertainty, including the prospect of a change in Prime Minister, adds further headwinds through higher borrowing costs and gilt yield pressure.

Our base case is growth of 1.0% this year with inflation trending back towards 4%, another dose of 'stagflation-lite' for the UK economy. The risks to that outlook are larger than usual and heavily dependent on how the situation in the Middle East develops. But the economy has grown at an average of 1.2% through two turbulent years, and the early signs suggest that resilience will hold.

How will the Iran war impact the UK economy?

The closure of the Strait of Hormuz represents the largest oil supply shock in history, yet energy markets have so far reacted with relative calm, with oil now at $79p/b and gas at 100p/therm, well below the post-Ukraine peaks. The buffer has been high global stocks, but these are being run down at a record rate and could reach critical levels by September if the June peace deal proves fragile.

If the Strait does not open and supply does not resume, a significant price surge remains a real risk. The UK is particularly exposed given its reliance on gas for electricity pricing, which is why the International Monetary Fund (IMF) has revised its UK inflation and growth forecasts more sharply than any other developed economy.

Will inflation come down this year?

Inflation briefly dipped below 3% for the first time since early 2025, but the reprieve will be short-lived. A 13% rise in the energy price cap in July, higher motor fuel costs, and pass-through effects from energy prices into food, goods and supply chains will push inflation back towards 3.5% by year end.

A weaker labour market and softer demand should prevent a repeat of 2022's double-digit spike, limiting second-round effects. Our base case is inflation averaging 3.1% in 2026, peaking around 3.5%, before easing to 2.5% in 2027, though risks loom large if the Strait of Hormuz remains closed.

Will the labour market improve in 2026?

The UK labour market was already softening before the latest energy shock, with unemployment rising to 5.0% and vacancies at their lowest since the pandemic. The pain is concentrated among younger and lower-paid workers, with the 16–24 unemployment rate jumping sharply over the past year. Firms are not yet shedding staff, but reluctance to hire is widening the gap between job growth and population growth.

Higher energy costs will compound the pressure, and we expect unemployment to peak at 5.3% by year end. With wage growth slowing to around 3.75% and inflation heading towards 3.5%, real pay looks set to be stagnant — another difficult year for living standards.

Will the Bank of England raise interest rates?

The Bank of England looks set to hold interest rates at 3.75% through 2026, rather than resume cutting as previously expected. Three factors limit the case for hikes: the energy shock is smaller than in 2022, rates are already at a restrictive level, and a weaker economy reduces the risk of second-round inflation effects.

That said, rate rises cannot be ruled out if energy prices surge further. Gilt yields are likely to remain elevated regardless, driven by the UK's inflation sensitivity and political uncertainty around a potential change of Prime Minister, keeping borrowing costs high across the economy even if the policy rate stays on hold.

What is the economic outlook for the UK economy?

Rising energy prices will push inflation to 3.5% by year end. We now forecast consumption growth of 1.0% and overall GDP growth of 1.0% this year, down from 1.4% in 2025, another year of stagflation-lite, with a modest recovery in 2027 as inflation fades and rate cuts follow.

What are the key risks to UK economic growth this year?

The risks to the UK outlook have grown considerably since the start of the year. The June peace deal proving fragile and leading to a prolonged closure of the Strait of Hormuz remains the biggest threat. If supply does not resume before stocks run dry, oil prices could surpass 2022 peaks, forcing second-round inflation effects, interest rate rises and a sharp fall in real household incomes making recession likely.

On the domestic front, a Labour leadership contest now looks inevitable, raising the prospect of higher borrowing, further gilt yield pressure and renewed tax uncertainty weighing on business and consumer confidence. Our base case remains ‘stagflation-lite’, but if either risk materialises or both combine a short recession later this year cannot be ruled out.