OECD Economic Outlook, Volume 2025 Issue 2

United Kingdom

GDP growth is projected to ease to 1.2% in 2026, due to the continued effect of budgetary tightening on consumption and to the drag from global uncertainty, before edging up to 1.3% in 2027, supported by business investment and exports as financial conditions and global trade improve. Renewed price pressures are expected to be transitory, with headline inflation remaining elevated at 2.5% in 2026 and easing to 2.1% in 2027, though staying above target over the entire period. Slack will emerge in the labour market, as employment and vacancies fall, with the unemployment rate projected to reach 5.0% in 2027.

The monetary policy stance is expected to become neutral as the easing cycle ends. At the same time, fiscal policy will remain restrictive given high government borrowing costs, as well as large, albeit declining, budget deficits and rising public debt. Continuing to ensure that consolidation is carefully timed, given substantial downside risks to growth and upside risks to inflation, and well-calibrated, with a combination of revenue-raising measures and spending cuts, is essential. Tax and spending measures should also aim to further support growth potential, complementing ongoing structural reforms such as the overhaul of infrastructure planning and the simplification of financial services regulation.

Momentum is softening

Flash estimates indicate that GDP growth slowed to 0.1% in the third quarter, down from 0.3% in the second quarter, partly reflecting a large fall in output at a major vehicle manufacturer following a cyber incident in September. While business surveys point to improving conditions in both services and manufacturing, momentum is softer than at the beginning of the year. This is despite a robust expansion of credit to businesses, of 6.3% in the year to September, helped by monetary easing. Gilt yields have been volatile and remained relatively high over the past months, at around 4.6%, reflecting both domestic and global factors. The labour market is cooling, with the number of payrolled employees falling by about 0.4% in the year to September, and the number of vacancies declining by almost 14% over the same period. However, the recent rise in payroll taxes and in the minimum wage has slowed labour cost disinflation. Annual pay growth in the private sector reached 4.4% in the three months to September, even though pay settlements have declined more rapidly. CPI inflation remained elevated at 3.6% in October, largely driven by earlier rises in food prices and in a range of administered prices.

Merchandise export volumes continued declining in the year to September, with goods exports to the United States falling in value terms since the second quarter of 2025. Survey measures of new manufacturing export orders are weak. This reflects the 7 percentage point increase in the aggregate effective tariff rate faced by domestic goods exporters in US markets since the beginning of the year, despite the recent bilateral trade agreement. By contrast, services trade has continued to grow steadily. Sterling has appreciated in nominal terms against the US dollar in the year to date but depreciated against the euro, leaving the nominal effective exchange rate mostly stable.

United Kingdom 1

1. Survey measures of one-year ahead CPI inflation expectations.

Source: Bank of England; Office for National Statistics; and YouGov/Citigroup.

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United Kingdom: Demand, output and prices

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United Kingdom 2

1. Public sector excluding public sector banks; rolling 12-month average.

2. Household, business, and government gross fixed capital investment; net contribution of stockbuilding not shown.

3. Household and government consumption.

Source: OECD Economic Outlook 118 database; Office for National Statistics; and OECD calculations.

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Fiscal policy will remain restrictive as monetary policy becomes neutral

The cycle of monetary easing initiated in August 2024 is set to end in the second quarter of 2026, with Bank Rate settling at a terminal value of 3.5% after two more 25-basis-point cuts. The Bank of England is expected to look through the recent uptick in CPI inflation, largely due to transitory factors, as the loosening of the labour market slows underlying price pressures. The central bank is also assumed to continue unwinding the stock of assets held for monetary purposes in the Asset Purchase Facility, with the GBP 70 billion target for gilt stock reduction over the 12-month period to September 2026 renewed for another year.

Fiscal tightening will continue over 2025-27, albeit at a more moderate pace, as the government implements a frontloaded increase in spending of about 0.3% of GDP and a backloaded rise in taxes of about 0.9% of GDP over 2025-2029 to comply with its fiscal rules. Rising defence and related security and intelligence spending, from 2.3% of GDP in 2024 to 2.6% in 2027, and the steady increase in debt interest will keep adding pressure on public finances. The government deficit will remain large but should improve substantially, from 5.9% of GDP in 2025 to 5.1% in 2027, as total revenue reaches 40% of GDP.

Growth is set to be steady

GDP is projected to expand by 1.2% in 2026 and by 1.3% in 2027. Continued fiscal consolidation will be a headwind to the economy, with past tax and spending adjustments weighing on household disposable income and slowing consumption. Sluggish labour productivity and weak working-age population growth, partly due to slowing inward migration, will continue to act as a drag on the economy. At the same time, lower interest rates and a gradual improvement in global trade growth are expected to start providing moderate tailwinds from the second half of 2026, with investment and exports supporting the economy. CPI inflation will subside to 2.1% in 2027, down from 2.5% in 2026, reflecting recent measures that lower the cost of energy and fuel, as well as the elimination of base effects from past changes in food and administered prices. The loosening of the labour market will support disinflation, with core inflation slowing from 2.9% in 2026 to 2.2% in 2027. Unemployment is set to rise to 4.9% in 2026 and 5.0% in 2027, as labour demand continues slowing and the extension of childcare support promotes labour force participation.

Elevated inflation expectations and potential second-round effects from increases in payroll taxes and the minimum wage, as well as from high food inflation, constitute an upside risk to prices. This could require the monetary stance to stay tighter for longer, posing a downside risk to output. Downside risks also arise from the limited scope for the government to provide adequate support in the event of adverse shocks, given persistent pressures on the public finances. Relatively high excess savings remain an upside risk to private consumption and housing investment.

Simplifying regulation and implementing planned reforms would boost growth

Ongoing budgetary prudence is required to deliver on the government’s Growth Mission while ensuring fiscal sustainability, with a balanced approach combining revenue-raising measures, spending cuts, and productivity-enhancing investments. Continuing to adequately time and calibrate the consolidation is key to limit the adverse effects on near-term growth and inflation. At the same time, tax and spending policies should place more emphasis on expanding supply. Swift implementation of the ongoing overhaul of the National Planning Policy Framework to unlock infrastructure projects and housing development remains essential, as well as continuing to promote labour market participation, in part by delivering health-related welfare reforms, including the abolition of the Work Capability Assessment. Carefully advancing plans to simplify the regulation of financial services, guided by the government’s Financial Services Growth and Competitiveness Strategy, could further boost aggregate growth potential given the weight of the financial sector.