Nicolas Gonne
OECD
OECD Economic Surveys: United Kingdom 2026
Abstract
The government has introduced a broad set of growth-enhancing policies under its “Growth Mission”, focusing on public investment, planning reform and infrastructure delivery, simplified financial regulation, and a new industrial strategy. These structural reforms appropriately target long-standing weaknesses in productivity and persistent regional disparities. However, renewed geopolitical tensions and higher energy prices have compounded challenges for economic activity, inflation and public finances. Delivering the government’s priorities sustainably will require rebuilding fiscal space at a time of high public debt and rising long‑term spending pressures. Further strengthening the fiscal framework, restraining expenditure based on effective scope for savings, and improving tax efficiency would help rebuild fiscal buffers and support long-term growth.
1.1.1. External shocks and structural constraints have eroded living standards
The UK economy has experienced weak growth over the past decade (Figure 1.1, Panel A), resulting in broadly stagnant living standards. This reflects a succession of major exogenous shocks, including the exit from the EU Single Market, the COVID-19 pandemic, sharp increases in global energy prices and new US tariffs, which have weighed on business investment, private consumption and external demand. Elevated uncertainty and frequent policy shifts have further stifled business sentiment and consumer confidence. At the same time, energy-driven inflationary pressures have been stronger than in many OECD economies, squeezing real incomes. These developments have exposed and amplified underlying supply-side weaknesses, which continue to constrain growth.
Potential growth has weakened since the mid-2010s (Figure 1.1, Panel B), reflecting structural constraints. This slowdown has been primarily driven by weak productivity growth, linked to a long-standing weakness in business investment, lower trade intensity, skill mismatches and persistent regional disparities. More recently, labour supply has also weakened, with lower participation linked to health-related inactivity and reduced inward labour migration, further constraining working-age population growth. Together these factors have reduced the economy’s potential to expand, while persistent pressures on public finances further limit the government’s capacity to finance growth-enhancing reforms.
Note: G7 and OECD refer to weighted averages.
Source: OECD Economic Outlook: Statistics and Projections (database).
The government’s Growth Mission is broadly aligned with past OECD recommendations and provides an appropriate framework to address many of the UK economy’s long-standing weaknesses (Box 1.1). The strategy, which rightly recognises that stronger growth requires co-ordinated action across multiple policy areas, is being implemented. Sustaining the reform momentum is key, as success will depend on effective implementation, improved public sector delivery capacity, and ensuring that higher public investment remains consistent with medium term fiscal sustainability. In addition, maintaining a strong, competition‑friendly business environment and revitalising business dynamism, including by reducing barriers to firm entry and scaling, will be important to support investment, innovation and the diffusion of productivity gains across firms and regions.
In this context, complementary reforms discussed in this Survey to improve tax and spending efficiency, address long-term spending pressures (this chapter), strengthen work incentives and promote the adequacy and sustainability of retirement incomes (Chapter 2), accelerate investment in clean energy and electricity networks (Chapter 3) and reduce regional productivity gaps (Chapter 4) would support the effectiveness of the Growth Mission. OECD simulations suggest that a coherent and well implemented reform package, combining measures already under way with additional complementary reforms, could raise the level of potential GDP by about 4% within a decade (Table 1.1).
Relative to baseline level of potential GDP, %
Note: Quantification of structural reforms based on simulations using the OECD Long-Term Model and using cross-country econometric estimates of the relationship between policy indicators and trend labour efficiency, capital deepening and employment rates. Many assumptions and uncertainties underlie these estimates. Only some of the reform recommendations are covered. See OECD (2025[1]) and references therein for details. Quantification: (1) Recovery of one half of the decline in the economic globalisation index relative to the EU average. (2) Reallocation of R&D expenditure to ensure additionality, equivalent to an increase in total expenditure of 1% point over 5 years. (3) Increase in expenditure on active labour market policies by 15% points of GDP per capita per unemployed. (5) Equivalent to an increase of about 2% of GDP in business (two thirds) and public (one third) investment.
Source: OECD calculations.
Renewed energy price increases linked to the evolving conflict in the Middle East have compounded existing challenges, underscoring the UK economy’s continued exposure to external supply shocks and the need to strengthen both the supply side and public finances. The country was particularly affected by lasting price pressures in the wake of the 2021-2023 energy crisis, partly due to its dependence on natural gas, but also to an exceptionally tight labour market in the post-pandemic recovery, which led to significant second-round effects. The resulting lingering inflation and weak growth have been constraining monetary and fiscal policy choices. At the same time, broad-based energy support measures in response to the crisis, while helping to cushion households and firms, also reduced fiscal space and weakened price signals for energy efficiency.
As the latest energy price shock unfolds, the policy challenge is to cushion vulnerable households while preserving incentives to reduce energy consumption and rebuild fiscal buffers. Support measures should remain temporary and targeted to households most in need and to viable firms, and incorporate clear expiry mechanisms. The government’s fiscal response is appropriately targeted, in line with OECD advice (OECD, 2026[2]). At the same time, renewed energy price volatility reinforces the importance of strengthening domestic energy security and reducing exposure to external shocks.
The Growth Mission places economic growth at the centre of the government’s policymaking, with the objective of higher productivity and living standards across the United Kingdom. The strategy seeks to address long-standing weaknesses in business investment, infrastructure delivery, labour supply and regional productivity through a broad reform agenda. Growth is seen as the main channel for raising real household incomes, improving fiscal sustainability and supporting public services after a prolonged period of weak productivity and business investment.
Key policy pillars
Fiscal and macroeconomic stability: Strengthened fiscal rules and predictable tax and spending policy aiming to support confidence among households, firms and investors.
Public and private investment: Increase and improve the allocation of investment across sectors and regions.
Structural reform: Reduce long‑standing barriers to growth, particularly in planning, infrastructure delivery and regulation.
Industrial policy: A renewed ten‑year industrial strategy (Invest 2035) seeks to improve investment certainty and support sectoral and cluster‑based specialisation, aligned with net zero, economic security and regional development objectives.
Labour supply and skills: Increase effective labour input and reduce skill mismatches that constrain productive capacity.
Effective implementation will depend on strengthening administrative capacity and co-ordination across levels of government, addressing persistent planning and infrastructure bottlenecks, and ensuring that public initiatives crowd in private investment in a higher‑cost capital environment. The government has initiated reforms in key areas, including planning, investment frameworks and labour supply, but translating these measures into sustained productivity and growth gains will take time. Skills shortages and uneven local capacity may limit the impact of reforms, while maintaining fiscal discipline and political support will be essential to achieving the strategy’s objectives.
1.1.2. GDP recovered, though modestly
After a standstill during the 2021-2023 energy crisis, economic growth strengthened gradually over 2024-2025. Real GDP grew by about 2.5% cumulatively since the last Economic Survey (OECD, 2026[5]). Domestic demand led the recovery, more than offsetting the negative contribution from external demand (Figure 1.2, Panel A). Declining energy and food price inflation boosted real household income and supported a broad-based expansion in services (Figure 1.2, Panel B). At the same time, productivity strengthened over 2025 (ONS, 2026[6]). By contrast, slowing global trade growth and higher trade barriers held back goods exports (Figure 1.2, Panel C). Momentum remains uncertain in 2026. Before the start of the evolving conflict in the Middle East, survey-based leading indicators pointed to improving conditions since the beginning of the year, while GDP grew by 0.6% in the first quarter. Consumer confidence and business sentiment had strengthened overall, although from low levels and despite anticipations of fiscal consolidation.
Monetary and fiscal policy settings jointly supported the recovery between mid-2024 and mid-2025, before fiscal policy started tightening (Figure 1.2, Panel D). Monetary easing supported GDP growth by reducing the drag on demand, contributing to a recovery in credit growth to the private sector and helping construction activity. By contrast, fiscal policy has become more restrictive, with frozen tax thresholds reducing household disposable income and the recent increase in employer social security contributions partly borne by workers. At the same time, the higher minimum wage, together with elevated global uncertainty, have been weighing on business activity.
Note: Panel D refers to monetary financial institutions’ sterling net lending to private sector companies and households excluding intermediate OFCs and to the 12-month rolling average of public sector current budget deficit excluding public sector banks, respectively.
Source: Bank of England; Bloomberg; OECD Economic Outlook: Statistics and Projections (database); and Office for National Statistics.
1.1.3. Renewed imported inflation is adding to sticky domestic price pressures
Imported price pressures are rising again, interrupting the earlier disinflationary trend. The evolving conflict in the Middle East has pushed up oil and gas prices, with passthrough effects already visible. Still, headline price pressures have declined from their 2022 peak, with CPI inflation hovering around 3% in early 2026, reflecting the prior unwinding of imported price pressures before the start of the conflict (Figure 1.3, Panel A). Core inflation has also moderated but remains above 2.5%, largely owing to domestic cost pressures, as reflected in elevated services inflation.
Nominal wage growth has declined slowly since its 2023 peak, reflecting a protracted normalisation from unprecedented labour market tightness, with the vacancy-to-unemployment ratio below its estimated equilibrium level (BoE, 2025[7]). The available data point to growing slack in the labour market (Figure 1.3, Panel B), with the uptick in unemployment reflecting not only slowing labour demand, but also inflows out of inactivity and, increasingly, redundancies (ONS, 2026[8]). However, quality issues with the labour force survey remain, complicating assessments of the balance of demand and supply (OECD, 2024[9]).
Source: Bank of England; OECD Economic Outlook: Statistics and Projections (database); and Office for National Statistics.
Containing labour costs is key for both price stability and competitiveness. Significant increases in the minimum wage over 2024-2025 contributed to higher labour costs as productivity growth remained subdued (Figure 1.3, Panel C), while new “day-one” employment rights could push them even higher. Other factors have sustained the rise in labour costs, including weakness in labour market participation and a rise in the medium-term equilibrium unemployment rate, which have increased workers’ bargaining power, as well as pockets of skill shortages in specific areas and occupations (Chapter 4). At the same time, UK unit labour costs have not diverged significantly from those of main trading partners (OECD, 2026[10]).
The government should ensure that increases in the minimum wage remain in line with productivity growth. Delaying further minimum wage raises could be necessary to avoid exacerbating the current energy price shock, reduce the risk of second-round effects and safeguard competitiveness. The minimum wage grew steadily since 2020, largely reflecting the policy to raise it to two-thirds of median earnings, but it is expected to slow as the target was reached and will not be raised. Still, close monitoring of unit labour cost developments is particularly important given both still-elevated inflation expectations and growing slack in the economy.
Over the medium term, raising output potential is essential to sustainably reduce domestic inflationary pressures. Structural reforms to boost investment, support employment and improve productivity (Chapter 4) are therefore key to durably easing inflationary pressures while raising living standards.
1.1.4. Trade weakness is structural
Subdued trade performance, especially the persistent weakness in goods exports, is largely due to the permanent increase in trade costs following the exit from the EU single market (WTO, 2025[11]; OECD, 2024[9]), with the EU remaining the country’s largest trading partner (Figure 1.4, Panel A). Such weakness is only partly offset by the strong performance in services exports, given the country’s global leadership in financial services and digital trade (Figure 1.4, Panel B). Global trade fragmentation and the rise in tariffs compound post-Brexit challenges, given the importance of the US market for UK exporters (Figure 1.4, Panel C).
Other factors, including higher real unit labour costs (above) and elevated industrial electricity prices (Chapter 3), have added a further drag on competitiveness in the recovery from the 2022-23 energy crisis. The appreciation of the exchange rate also weighed on exports, with the real effective exchange rate assessed to be overvalued by about 6.5% in 2024, mostly driven by the nominal exchange rate (IMF, 2025[12]). In addition, UK exporters’ switch from sterling to US dollar invoicing for non-EU trade after the exit from the EU single market could have structurally depressed demand for UK exports, given the appreciation of the dollar relative to the pound until late 2024 (Garofalo, Rosso and Vicquéry, 2024[13]).
Trade barriers with the EU market are particularly detrimental to the United Kingdom’s export performance. While the European Union remains a key export market, the United Kingdom’s relative importance for EU trade has declined markedly (Figure 1.4, Panel D). Despite the Trade and Co-operation Agreement, which allows for zero-tariff, zero-quota trade between the European Union and the United Kingdom, UK exporters face significantly higher trade costs than under EU membership, due to new border checks, requirements and other frictions (OECD, 2024[9]). These higher costs have disproportionately affected small firms, while exports by large firms, including multinationals, appear largely unaffected (WTO, 2025[11]). They have also contributed to imported inflationary pressures, especially due to higher imported food items (Bakker, Datta and Davies, 2023[14]).
Efforts should continue to reduce non-tariff barriers for EU-UK trade and to improve mutual market access for services. In 2023, the Trade and Co-operation Agreement was supplemented with the Windsor Agreement, a set of joint solutions designed to address issues regarding the movement of products and people in Northern Ireland. In 2025, it was further supplemented with the so-called Joint Statement, Common Understanding, and Security and Defence Partnership package, which sets out commitments towards establishing a common sanitary and phytosanitary area, linking the UK and EU emissions trading schemes, exploring a UK participation in the EU internal electricity market, and other areas to strengthen bilateral co-operation, including in defence and education. These are important steps in the right direction.
Continuing to expand market opportunities through new trade agreements, as part of the new UK Trade Strategy (Box 1.2), while cutting non-tariff barriers that raise trade costs, would further support competitiveness. The most recent deals include the new regional trade agreements with India, and the so-called “General Terms for the United States of America and the United Kingdom of Great Britain and Northern Ireland Economic Prosperity Deal” with the United States, though the benefits from the latter are surrounded by uncertainty following the recent US Supreme Court ruling against some of the tariffs imposed on foreign competitors in the US market. By contrast, the complexity of the UK Most Favoured Nation tariff framework (“UK Global Tariff”) pushes up trade costs, with dozens of ad valorem rates, non-ad valorem duties, tariff rate quotas, and seasonal tariffs (WTO, 2025[11]). Streamlining the tariff framework, or even suspending duties on inputs for domestic production, would support competitiveness.
Source: UN Comtrade; OECD International Trade in Services (database); IMF International Trade in Goods (database); Office for National Statistics (ONS); and OECD National Accounts (database).
The current account deficit remains relatively high, largely reflecting structural trade weakness (Figure 1.4, Panel E). This is despite the normalisation of the primary income balance, after a deterioration in the recovery from the energy crisis, as rising yields on debt liabilities outweigh returns on external assets. Overall, the external position is moderately weaker than the level implied by medium-term fundamentals and desirable policies (IMF, 2025[15]). Large government deficits are the key driver of the current account deficit (Figure 1.4, Panel F). Thus, ongoing fiscal consolidation will contribute to narrowing the current account gap.
In June 2025, the United Kingdom launched a comprehensive Trade Strategy marking a transition from a singular focus on broad Free Trade Agreements (FTAs) to a more agile, sector-specific approach. Termed "pragmatic patriotism," the strategy prioritizes the UK's "services superpower" status and advanced manufacturing base while navigating increasing geoeconomic fragmentation. Key pillars include the alignment of trade with national industrial priorities—particularly green growth and digital innovation—and the deployment of a new "Ricardo Fund" to dismantle technical and regulatory barriers in high-potential markets.
Progress since April 2025 reflects this accelerated, multifaceted engagement. A landmark Free Trade Agreement with India was signed in July 2025, anticipated to bolster bilateral trade by an estimated £25.5 billion through significant tariff reductions in automotive, spirits, and life sciences sectors. Simultaneously, the UK secured an "Economic Prosperity Deal" with the United States in May 2025, aimed at mitigating specific tariff burdens and strengthening critical technology partnerships. Relations with the European Union have also seen a pragmatic reset, highlighted by the May 2025 agreement on a Sanitary and Phytosanitary (SPS) framework, which facilitates trade in agri-food products by reducing border frictions.
Institutionally, the UK joined the Multi-Party Interim Appeal Arbitration Arrangement (MPIA) in late 2025 to safeguard dispute settlement amid World Trade Organization (WTO) challenges. This, coupled with the full integration into the CPTPP as of December 2024, positions the UK to leverage deeper supply-chain integration across the Asia-Pacific. The strategic focus remains on securing "nimble" arrangements that provide immediate market access improvements, ensuring that trade policy acts as a direct catalyst for domestic economic security and long-term productivity.
Source: HM Government; and World Trade Organisation.
1.1.5. Growth will slow as the evolving conflict in the Middle East unfolds
Economic activity will slow temporarily in the near term (Table 1.2), reflecting not only the supply shock from the surge in global energy prices, like in most other OECD countries, but also tight fiscal policy, remaining monetary restriction, and persistent structural constraints. GDP growth is projected to moderate to 0.9% in 2026, due to renewed global energy price inflation, the drag from global uncertainty, as well as the continued effect of fiscal consolidation on household disposable income and consumption. It will then pick up to 1.1% in 2027, mainly supported by government expenditure despite consolidation, but also business investment and exports as lower interest rates, stronger financial conditions and a gradual improvement in global trade start providing moderate tailwinds to the economy. Monetary policy is assumed to look through the energy shock in 2026 and continue easing towards a neutral stance in 2027, reducing but not eliminating the drag on growth as fiscal policy will remain restrictive.
Inflation will remain elevated and above the 2% target over the projection horizon. Annual headline inflation is projected to reach 3.7% in 2026, due to renewed global energy inflation owing to the evolving conflict in the Middle East, before moderating to 2.4% in 2027, as energy prices ease from the second half of 2026. The United Kingdom is particularly exposed to volatility in global energy prices, given its high dependence on natural gas for energy generation, high reset frequency of retail energy contracts, and low storage and hedging. Easing labour market conditions are expected to continue supporting disinflation, with core inflation slowing from 3.5% in 2025 to 2.7% in 2027.
Significant slack in the labour market will help contain domestic price pressures but also dampen income growth and consumption. This is in stark contrast with the previous energy shock of 2021-2023, when the labour market was unprecedentedly tight due to the post-pandemic recovery. Unemployment is set to rise to 5.5% in 2026 and 5.3% in 2027, reflecting lower labour demand as the economy slows, but also the extension of childcare support, which promotes labour force participation (OECD, 2024[9]).
Annual % change, unless specified
1. Contributions to changes in real GDP; actual amount in the first column.
Source: OECD Economic Outlook: Statistics and Projections (database).
Risks to the outlook are tilted to the downside, mainly reflecting external shocks in conjunction with the limited fiscal space. The main downside risk to growth stems from geopolitical tensions. Higher global energy prices for longer due to a protracted conflict in the Middle East would weigh on real incomes and result in a larger rise in unemployment and higher precautionary savings. This would also worsen business sentiment and depress energy-intensive industries, weighing on business activity. In such a prolonged disruption scenario, global growth is expected to slow significantly, pushing several economies into or close to recession (OECD, 2026[2]). In addition, prolonged constraints on fertiliser supply would push up food inflation. At the same time, a more pronounced slowdown would widen the output gap and reduce domestic inflationary pressures.
Further trade fragmentation is the other key external risk. With exports and imports of goods and services accounting for more than 60% of UK GDP in 2024, renewed trade uncertainty and higher US tariffs on goods from key sectors (such as machinery and transport equipment, including cars and car parts, and of pharmaceutical products) would directly weaken export growth, even as the large share of services in total exports provides some mitigation. Moreover, higher input costs for UK importers of US intermediate goods, including semiconductors and metals, would depress competitiveness in other UK export markets, hence weaken export growth indirectly. In addition, worsening trade tensions could entail an economic downturn in key trading partners, hence dampen external demand further and weigh on business confidence and investment, which could spill over into weaker private consumption. On the upside, trade diversion could lead to lower UK import prices, reducing inflationary pressures and supporting competitiveness.
Domestically, elevated inflation expectations and potential second-round effects from increases in global energy prices, as well as from past rises in payroll taxes and the minimum wage, 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 support in the event of adverse shocks, for instance to attenuate the impact of higher energy prices on households, given persistent pressures on the public finances.
Lower-than-expected returns from artificial intelligence investment could trigger more widespread risk repricing in financial markets, with adverse consequences for private demand. By contrast, sustained productivity growth is an upside risk, given the weight of those sectors that have been the greatest adopters of artificial intelligence technologies in the UK economy, such as finance and professional services. Relatively high excess savings remain an upside risk to private consumption and housing investment. Several low-probability events could alter the outlook significantly (Table 1.3).
1.2.1. The balance of inflation risks is highly uncertain
The monetary policy stance has eased, with the Bank Rate reduced gradually from its summer 2024 peak, as significant monetary policy restriction helped to reduce inflation (Figure 1.5, Panel A). The real policy rate, measured as Bank Rate deflated by one-year ahead annual core inflation, has stabilised close to or within the range of estimates for the real neutral rate defined as the rate at which the policy stance is neither accommodative nor restrictive (OECD, 2025[16]; BoE, 2026[17]). Policy remains restrictive, albeit significantly less than before, with past tightening still weighing on demand and contributing to the disinflationary process. Real short-term interest rates edged up after easing significantly while, like in many other advanced OECD economies, forward-looking long-term real rates remain well above pre-pandemic norms (Figure 1.5, Panel B).
Note: Panel A refers to Bank Rate and to Bank Rate deflated by one-year-ahead annual core inflation (realised or projected). Panel B refers to nominal one-year gilt yields deflated by consumer one-year-ahead inflation expectations and to 10-year index-linked gilt yields. Panel C refers to survey measures of one-year ahead inflation expectations. Panel D refers to firms’ own price and wage growth expectations over the next year.
Source: Bank of England; OECD Economic Outlook: Statistics and Projections (database); OECD calculations; and YouGov/Citigroup.
Maintaining a restrictive monetary policy stance remains warranted until underlying price pressures fall sustainably to levels consistent with the 2% inflation target. The inflation outlook strengthened again in early 2026, owing to the surge in global energy prices and given their salience for consumer expectations. This could add to persistent underlying domestic price pressures, particularly from wages and services, and already elevated inflation expectations (Figure 1.5, Panel C), with firms continuing to anticipate elevated wage and price growth (Figure 1.5, Panel D). At the same time, the growth outlook weakened significantly, with rising spare capacity and labour market slack, which will contribute to attenuating medium-term inflationary pressures as it limits second-round effects.
Monetary policy should therefore remain cautious and vigilant to shifts in the balance of risks. Transitory price developments, such as the current supply-induced rise in energy prices or a one-off tariff-induced increase in the relative price of tradeable goods, can be looked through provided inflation expectations remain well anchored (OECD, 2026[10]). However, monetary tightening would be needed if inflation expectations continued edging up and there were signs of broader price pressures feeding through domestic wages. By contrast, weaker labour market conditions and downward wage pressures may call for monetary loosening.
The Bank of England’s approach to setting Bank Rate adequately addresses inflation risks, given high inflation expectations and uncertainty around the true levels of the neutral interest rate. By framing policy decisions as meeting-by-meeting calls rather than following a pre-set path of gradual cuts, this approach balances the short-term upside risk to inflation from underlying price pressures and the medium-term downside risk from weaker demand. Such a flexible, data-dependent strategy is well suited to manage the withdrawal of remaining policy restriction. It also minimises the risk of mistakes, as it lowers the risk of reducing Bank Rate by too much, so requiring a policy reversal that would undermine credibility.
1.2.2. Quantitative tightening has supported the normalisation of monetary policy
The Bank of England has proceeded with quantitative tightening, through both active sales and redemptions of government bonds (“gilts”) held in the Asset Purchase Facility. Gradual and predictable implementation has contributed towards the normalisation of the Bank’s balance sheet, while limiting market disruption. The quantitative tightening cycle also promoted the effectiveness of potential future quantitative easing cycles, by reinforcing the principle of a countercyclical tool to be used when support is needed and be unwound when conditions allow.
At the same time, quantitative tightening has raised borrowing costs and generated fiscal spillovers, with estimates ranging from a 15–25 basis points increase on long-term interest rates (BoE, 2025[18]) to a cumulative impact of 44–70 basis points on gilt yields at maturities of one year and longer (Du, Forbes and Luzzetti, 2024[19]). In addition, higher Bank Rate and asset sales have led to income and capital losses for the Bank. These entail a significant fiscal cost to the public finances (about 0.5% of GDP in FY2025-26), given the indemnification arrangement between HM Treasury and the Bank of England. Yet, any cost-benefit analysis should account for the broader impact on the economy of the whole unconventional monetary policy cycle.
The ongoing transition to a repo-led monetary framework reduces risks for both the Bank of England and the public finances. Operations have shifted from a supply-driven regime, in which reserves were created in fixed quantities through outright asset purchases, to a demand-driven regime, in which reserves are supplied elastically at a price through asset repurchase agreements (BoE, 2024[20]). This significantly reduces the Bank’s exposure to interest rate risks by better aligning the interest rate sensitivity of assets and liabilities, as repo contracts are indexed to Bank Rate. Fiscal risks to the public finances are also attenuated, as the repo framework is backed by capital rather than indemnified. Finally, the demand-driven framework supports financial stability by design because it fully meets commercial banks’ demand for payments and precautionary purposes.
Completing the transition to the new monetary framework is key to maintaining effective monetary control at lower risk. The short-term repo and indexed long-term repo facilities have become the primary source of additional liquidity to the banking system. However, the transition can only be complete when the Bank of England’s reserves fall to the level needed to satisfy demand from commercial banks through repo (so-called “preferred minimum reserve requirement”). Continuing to improve high-frequency indicators of reserve capacity, possibly based on spreads between Bank Rate and private repo market rates, would further improve the management of reserve scarcity and help to conclude quantitative tightening smoothly. Recent measures to reduce the stigma associated with commercial banks using standing liquidity facilities, especially the discount window facility, through lower pricing and proactive communication will help to enhance the efficiency and resilience of the overall framework.
1.2.3. Better forecasting and communication will help monetary policy effectiveness
Ongoing reforms to the Bank of England’s forecasting and communication are improving the effectiveness of monetary policy. The Bank is implementing the recommendations from the independent review of its forecasting, policy and communication processes to improve the management of long-term inflation expectations (Bernanke, 2024[21]). Investments to update the forecasting infrastructure, including data systems, analytical tools and software are underway, alongside efforts to improve transparency about how forecasts inform policy decisions. Moreover, greater emphasis on scenario-based communication, instead of a single market-conditioned central forecast, better reflects uncertainty around inflation persistence. In addition, systematic forecast evaluations were carried out (BoE, 2026[22]).
The Bank of England should continue implementing the reforms to strengthen forecasting capacity and communication. Swiftly migrating analytical functions to the new infrastructure and phasing in new software and models is necessary to embed them into the monetary decision-making process. Improving the presentation of risks and scenarios would help anchor expectations and reinforce the effectiveness of a cautious, data-driven monetary policy strategy. Communication could also be improved by establishing high-level principles for selecting and/or changing the central scenario.
1.3.1. Households and corporates are resilient, but pockets of debt vulnerabilities exist
Household balance sheets remain resilient in aggregate, but vulnerabilities have emerged among specific groups. Household debt is moderate (Figure 1.6, Panel A) and relatively few households are in arrears or face high debt-servicing burdens (BoE, 2025[23]). In addition, aggregate household savings remain elevated, supporting households’ ability to absorb adverse shocks. However, downward pressure on real incomes owing to the evolving conflict in the Middle East could strain household finances (Table 1.2). In addition, vulnerabilities persist among some groups, particularly renters, as reflected in a widening gap in median savings-to-income ratios between outright owners and renters. In the event of an adverse economic shock, sudden spending cuts or higher default rates among renters could amplify macro-financial risks and pose challenges to financial stability (BoE, 2025[23]).
Housing market risks appear contained, but mortgage refinancing and rental affordability remain sources of pressure. House prices have strengthened moderately and mortgage approvals have returned to pre-pandemic levels, while quoted mortgage rates have declined from their post-pandemic peak but shot up again in the wake of the evolving conflict in the Middle East (Figure 1.6, Panels B and C). However, the full pass-through of higher interest rates has yet to materialise for some mortgage holders, with around four out of ten mortgage accounts still expected to refix at higher rates, implying continued pressure on a subset of households (BoE, 2025[23]). At the same time, rents have continued to rise amid constrained housing supply, exacerbating affordability challenges for lower-income households (OECD, 2024[9]).
Corporate sector risks are limited overall and remain concentrated among high-risk borrowers. Non-financial corporate debt is relatively low (Figure 1.6, Panel D), while aggregate net debt-to-earnings ratios remain well below their pandemic and post-global financial crisis peaks (BoE, 2025[23]). Funding conditions for corporates have been benign, insolvency rates remain below their long-term average, and credit spreads are compressed (OECD, 2025[16]). Spillovers to the United Kingdom from two recent high-profile corporate defaults in the United States have been limited. Nevertheless, refinancing costs have increased for corporate bond issuers, particularly for higher-risk borrowers reliant on leveraged loans and private credit, which typically have shorter maturities and are therefore more exposed to higher interest rates. This creates pockets of vulnerability and warrants close monitoring.
Note: Panel C refers to average quotes for 5-year fixed rate (75% LTV), to sterling weighted average rates on loans and new advances to private non-financial corporations, and to mortgage approvals for house purchase to individuals.
Source: Bank of England; OECD Analytical House Prices Indicators (database); and OECD National Accounts (database).
1.3.2. Prudential policy needs to balance global risks and domestic credit supply
The banking system is well capitalised, asset quality is strong and non-performing loans remain low (Figure 1.7, Panels A to D), ensuring substantial loss-absorption capacity against potential systemic shocks. Liquidity conditions remain robust, as commercial banks have maintained adequate levels of liquidity throughout the structural transition to the demand-driven monetary framework (BoE, 2025[23]). According to the Bank of England’s 2025 main Bank Capital Stress Tests, the system is sufficiently resilient to support households and businesses in significantly worse economic conditions than currently expected, with bank capital remaining well above the sum of aggregate regulatory minima and systemic buffers even under severe stress (a hypothetical global supply shock leading to a 5% contraction in UK GDP and a sharp rise in inflation). In addition, the Bank Resolution (Recapitalisation) Act, in force since July 2025, further supports the resilience of the banking sector by setting a new recapitalisation mechanism based on industry levies, designed to limit market disruption from failures of small UK commercial banks and to facilitate orderly resolution.
Note: OECD refers to the average of countries with available data.
Source: International Monetary Fund.
The counter-cyclical capital buffer has been maintained at its neutral setting of 2%. This is appropriate, as immediate risks are concentrated in financial markets, reflecting elevated global risks, including from stretched asset valuations (mostly AI-related) and compressed credit spreads (BoE, 2025[23]). In addition, the Bank of England has revised down its benchmark level of capital requirements, with the appropriate system-wide Tier 1 capital ratio assessed at around 13% of risk-weighted assets, 1% point lower than the previous benchmark. Moreover, the Prudential Regulation Authority has postponed the implementation of the Basel III.1 standards, which include tighter restrictions on commercial banks’ use of internal models to calculate risk-weighted assets. These adjustments balance supportive domestic credit conditions and financial stability. Yet, continued macroprudential oversight remains necessary to mitigate risks stemming from prevailing global financial volatility, especially as the evolving conflict in the Middle East has raised repricing risks.
The financial supervisory authorities should continue to dynamically calibrate macroprudential settings while appropriately accounting for global financial risks. Higher capital buffers would help to contain the transmission of financial shocks as financial stability risks have increased, while lower buffers support credit growth, as well as the competitiveness of UK commercial banks. Close surveillance of credit aggregates and financial conditions is essential for the timely recalibration of the counter-cyclical capital buffer in response to changes in the risk environment. Swiftly easing prudential policy if financial conditions tighten and credit defaults rise would help to attenuate a credit-driven downturn.
Prudence is required in the ongoing modernisation of financial services regulation. While simplifying complex and obsolete rules can support growth and competitiveness in the financial sector, the primary objective of supervisory authorities should remain the preservation of stability and soundness. The ongoing consolidation of numerous relatively small pension funds is welcome as it will improve efficiency by reducing transaction fees and enabling investments in a wider range of assets. However, as highlighted in the last Economic Survey, plans for mobilising pension funds for domestic investment should not interfere with pension funds’ fiduciary duty to act in the best interest of their members (OECD, 2024[9]).
1.3.3. The growth in private credit requires closer oversight
Non-bank financial intermediation is a central feature of UK corporate funding, accounting for more than half of total corporate debt (BoE, 2025[23]). It brings strong benefits for the private sector in terms of competition, diversification and risk allocation. Moreover, growing linkages between commercial banks and non-banks support credit provision to businesses, playing a critical role in the functioning of core UK markets, especially during periods of stress (BoE, 2025[23]). At the same time, this exacerbates interconnectedness and channels of risk transmission (FSB, 2025[24]).
Monitoring non-banks and improving their resilience is crucial to ensuring that the financial system can absorb shocks, rather than amplify them. The stability of non-bank finance in a broad-based macroeconomic stress is untested at its current size. Yet, high interest rates and a modest growth outlook can strain the liquidity of non-bank financial intermediaries. In addition, the growth in private credit, with less transparent transmission channels than market-based finance, obscures aggregate leverage and complicates risk assessments. The recent high-profile default of two non-bank US corporates with significant private credit footprint highlighted potential risks arising from excessive reliance on credit ratings providers as a substitute to appropriate due diligence.
The financial supervisory authorities should integrate private credit markets in system-wide stress-testing exercises. Stronger oversight of private credit is warranted to understand the propagation of potential shocks through the financial system, given the interconnectedness between commercial banks and non-banks. The first system-wide exploratory scenario, run in 2024, has already improved the understanding of how non-banks react under liquidity stress. The second such exercise, launched in December 2025, specifically focuses on financial intermediaries active in private markets. This is a welcome step in the direction of stress-testing the entire private market ecosystem, adding to the assessment of other “new” systemic risks (Box 1.3).
Non-bank financial intermediaries have a large footprint in the gilt and gilt repo markets, which are critical to the smooth functioning of the UK financial system. However, institutional investors like pension funds and insurers have reduced their holdings, while hedge funds and non-resident holders have increased their exposure. In addition, the Bank of England’s holdings are significantly lower than before quantitative tightening. The new prominence of more speculative and interest-sensitive holders tends to increase gilt yield volatility, hence the government’s borrowing costs.
The growing footprint of non-banks in the gilt market creates new risks to financial stability. Leveraged borrowing by hedge funds in gilt repo markets remains elevated, largely reflecting very high volumes of cash-futures basis trade concentrated in a small number of hedge funds (BoE, 2025[23]). These trades typically operate with very small margins, minimal collateral haircuts and very short maturities, requiring constant refinancing and creating significant vulnerabilities to a tightening of financial conditions.
The United Kingdom remains a global leader in stress-testing "non-traditional" systemic risks, specifically cyber-resilience and climate change. As geopolitical tensions escalate, the Bank of England has intensified its scrutiny of cyber-threats that pose significant risks to economic and financial stability. Following a 2022 exploratory test on retail payments, the BoE launched a subsequent exercise in 2024 targeting data integrity within wholesale payments and settlement. These initiatives, alongside the Financial Policy Committee’s 2024 macroprudential approach to operational resilience, are critical for quantifying the potential systemic impacts of sophisticated digital disruptions.
Simultaneously, the Bank of England is pioneering the assessment of climate-related financial risks and their cross-sectoral impacts on banks and insurers. Physical risks, including infrastructure damage and supply chain disruptions caused by extreme weather, threaten to erode institutional profitability and asset values. While current capital models and credit ratings increasingly incorporate climate variables, the complexity of long-term environmental forecasting suggests that existing risk capture remains incomplete.
The Bank’s proactive data collection on these emerging vulnerabilities is a necessary step towards maintaining financial integrity. To ensure the resilience of the UK’s financial centre, the BoE must continue to dynamically adapt its regulatory and supervisory frameworks. This evolution should be guided by the empirical insights gained from exploratory stress tests, ensuring that oversight keeps pace as "non-traditional" vulnerabilities transition into documented systemic threats.
Source: Bank of England; and OECD (2024[9]) OECD Economic Surveys: United Kingdom 2024.
The authorities should continue to enhance the resilience of the gilt and gilt repo markets as global uncertainty remains elevated. A range of structural reforms is under consideration, including greater central clearing of gilt repo and minimum margin requirements on non-centrally cleared gilt repo transactions (BoE, 2025[25]). However, given long implementation lags, preparedness should be strengthened in the interim. Conditional on adequate supervision and regulation, expanding access to the Contingent Non-Bank Financial Institution Repo Facility to a broader range of non-banks with significant footprint in the gilt market could help mitigate liquidity stress in case of shocks that temporarily increase non-banks’ market-wide demand for liquidity.
1.4.1. The fiscal stance remains moderately and adequately restrictive
The government deficit is set to improve over 2026-2027 as fiscal tightening continues (Figure 1.8, Panel A). The more-than-proportional increase in the cyclically-adjusted balance reflects discretionary adjustments in taxes and spending after the deterioration of 2023-2024. While the resulting fiscal stance is moderately restrictive, headline deficits improve only slowly, as subdued growth, pressure from welfare spending and high public debt interest partly offset the impact of fiscal consolidation on public finances (Figure 1.8, Panel B). At the same time, transfers from HM Treasury to the Bank of England under the Asset Purchase Facility indemnification arrangement continue to weigh on the deficit, although to a diminishing extent (see above).
The moderately restrictive fiscal stance remains adequate and should be maintained, despite the effects of the evolving conflict in the Middle East. Support for economic activity should continue to be gradually withdrawn as underlying inflation remains above target and the public finances are under pressure, with the government deficit among the highest in the OECD and gross public debt above 100% of GDP (Figure 1.8, Panels C to F). Monetary policy can handle supply shocks by balancing the rise in imported inflation and the transitory slowdown in economic activity. The pace of fiscal consolidation should, however, remain gradual given the ongoing energy shock and automatic stabilisers should be fully allowed to cushion the overall impact on the economy in the short run.
Note: Panel A refers to OECD forecast for 2026-2027. All figures refer to the general government.
Source: OECD Economic Outlook: Statistics and Projections (database).
If needed, any new discretionary measures should be well-targeted on households most in need and on viable firms, preserve incentives to lower energy use, and have clear expiry mechanisms. Additionally, temporary measures aimed at lowering headline inflation, such as the freeze of administered prices in energy and transport, or the extension of the fuel duty freeze, should be avoided. While they may ease cost of living pressures and provide a visible relief to households in the short term, they are fiscally costly, weaken energy and transport price signals and do not address underlying inflationary pressures.
1.4.2. The medium-term fiscal strategy aims to balance demand and public finances
The government’s medium-term fiscal strategy aims to support growth while restoring fiscal sustainability by increasing public investment and improving public service delivery, financed through a combination of higher taxes, additional borrowing and, over time, tighter control of current spending (Table 1.4). The strategy requires effective sequencing and hinges on the growth effect of new spending outweighing the adverse impact of some of the new taxes. The strategy appropriately prioritises investment and supply-side reforms, but its success depends on effective containment of spending growth across departments in later years, which may prove politically and economically challenging and require additional measures to ensure fiscal sustainability. Maintaining a sufficiently restrictive fiscal stance in the near term remains important to support the disinflation process and ensure a consistent macroeconomic policy mix.
% of GDP, unless specified
1. Gross fixed capital formation minus consumption of fixed capital.
2. General government gross interest paid.
3. National Accounts definition; includes state guarantees, among other items.
Source: OECD Economic Outlook: Statistics and Projections (database).
The credibility of the strategy depends on the effective implementation of the planned restraint in current spending. The 2025 spending review sets expenditure paths for this adjustment by capping real growth in current discretionary spending at 1.2% per year through FY2028-29, while allowing capital spending to grow by 1.8% annually over the same period, with a focus on infrastructure investment. Most of the increase in current spending is allocated to health and long-term care, particularly the National Health Service (HM Treasury, 2025). If delivered as planned, these measures would partly reverse the steady decline in real per capita spending on public services of the 2010s (OECD, 2025[26]).
The strategy is subject to important risks. If economic conditions weaken or political pressures intensify, future spending restraint may prove difficult to implement. Planning contingent fiscal measures would therefore help ensure that fiscal consolidation remains on track. Several options exist for immediate consolidation with limited adverse effects on growth or inequality. These include a temporary suspension of state pension indexation, as already done in FY2022-23 (Chapter 2), or a temporary windfall tax on energy producers, given the current energy supply shock. While these measures could support fiscal consolidation, additional adjustments will be required over time to ensure public debt remains on a sustainable path (see below). Given that the tax burden is already high, consolidation should rely primarily on expenditure restraint and improvements in tax efficiency rather than further increases in statutory tax rates.
Delivering the government’s reform agenda to expand supply will be essential for the fiscal strategy to succeed, as stronger growth would offset the adverse effects of higher taxes and rising spending pressures. Planned investment in infrastructure, innovation, industry support and skills under the Growth Mission, together with policies aimed at strengthening labour market participation under the Get Britain Working strategy are largely consistent with recommendations in previous Economic Surveys (OECD, 2024[9]; 2022[27]; 2020[28]). However, some policy measures have weakened supply incentives. In particular, the increase in employer social security contributions raises labour costs, while the indefinite pause in tightening eligibility for health-related benefits may reduce incentives to work.
1.4.3. The fiscal framework has improved, but gaps remain
The fiscal framework introduced in 2024 strengthens the credibility of fiscal policy (Box 1.4). The revised framework remains centred on a small number of well‑defined rules, supported by transparent monitoring from the Office for Budget Responsibility, providing a clear and easily communicable anchor for fiscal policy that enhances public understanding and accountability. The rules make greater space for public investment while limiting borrowing for day-to-day public spending, by replacing the previous deficit target with a current balance target. The framework also enhances the medium-term consistency of fiscal policy by shortening the target horizon to three years and aligning it with spending reviews. At the same time, the three-year horizon allows to look through the business cycle, avoiding the risk of pro-cyclicality. These reforms are broadly aligned with recommendations in the last survey (OECD, 2024[9]). However, while the extension of the debt target perimeter to encompass all financial assets and liabilities incentivises productive public investments, it also makes the framework less restrictive (OBR, 2024[29]).
The simplicity and clarity of the framework, while beneficial for transparency and accountability, also involve drawbacks, as the excessive focus on headline indicators continues to undermine the effectiveness of medium-term fiscal strategies. In particular, the emphasis on the fiscal headroom against fiscal targets at annual fiscal events encourages headline-focused announcements and short-term adjustment in tax and spending decisions in response to small forecast revisions. Treating headroom as a proxy for fiscal space in policy discussions also creates political pressure to announce new tax and spending measures when the margin against fiscal rules appears to increase. As a result, policy discussions risk focusing on short-term rule compliance rather than broader assessments of fiscal sustainability (van Geest, 2025[30]).
Reducing the emphasis on headroom would allow for a broader assessment of the fiscal situation and strengthen the effectiveness of the fiscal framework. One option would be to showcase forecast uncertainty alongside central projections of the fiscal headroom, for example by giving greater prominence to fan charts already produced in official forecasts. Complementing fiscal rules with additional indicators, such as gross financing needs, and of long-term sustainability, such as the required adjustment in primary revenue or equivalent saving to stabilise the debt-to-GDP ratio, would also provide a more comprehensive picture of fiscal risks.
New legislation limiting major tax and spending policy decisions to a single annual fiscal event streamlines the fiscal policy process, a welcome step towards greater predictability. Consistently treating the spring statement primarily as an update on the implementation of measures announced in the autumn budget will strengthen the stability of fiscal policy. At the same time, keeping two official forecasts per year remains important to support the transparency and credibility of the government’s fiscal strategy. The Office for Budget Responsibility has played a crucial role in fiscal discipline, including during challenging times of economic turmoil and political pressure (van Geest, 2025[30]). Ensuring that its resources remain commensurate with its mandate will be important to maintain its independence and effectiveness (OECD, 2025[31]).
The 2024 update to the Charter for Budget Responsibility introduced a refined fiscal architecture designed to reconcile long-term public investment with debt sustainability. This framework is anchored by two primary "fiscal rules" that shift the focus towards a more comprehensive balance-sheet perspective and a shorter horizon for day-to-day fiscal discipline.
The Stability Rule mandates that the current budget (the balance of day-to-day expenditure against tax receipts) must be in surplus or balance by the third year of the rolling forecast. By excluding capital investment from this target, the rule aims to prevent the historical tendency of "procyclical" cuts to infrastructure during periods of fiscal consolidation, ensuring that operational spending is fully funded by contemporary revenue.
The Investment Rule targets a reduction in public sector net financial liabilities (PSNFL) as a percentage of GDP by the fifth year of the forecast. This represents a strategic shift from the previous metric (PSND ex BoE). PSNFL provides a broader view of the national balance sheet by accounting for the value of financial assets, such as student loans and equity stakes, alongside liabilities. This "net" approach is intended to incentivize productive public investment, recognizing that expenditures which create liquid financial assets do not necessarily weaken the state's long-term fiscal solvency.
Underpinning these targets is a strengthened "fiscal lock," which legally mandates an independent assessment by the Office for Budget Responsibility (OBR) for any significant, permanent fiscal policy changes. This institutional safeguard enhances market credibility and transparency, ensuring that the transition towards a "pro-investment" stance remains anchored in a realistic and disciplined macroeconomic trajectory.
The Charter for Fiscal Responsibility was updated in February 2026 to deliver the government’s commitment to one major fiscal event per year.
Source: HM Treasury. (HMT, 2024[32])
Official forecasts may also be subject to a built-in optimistic bias because they are conditioned on the government’s stated policies (van Geest, 2025[30]). The risk is particularly evident when assumptions rely on announced future adjustments that have consistently been postponed. Fuel duty is one example: the baseline assumes indexation to inflation, but successive governments have repeatedly opted for nominal freezes. Such gaps between stated and actual policy can lead to systematic overstatements of future revenue or understatements of expenditure. Recent steps by the Office for Budget Responsibility and HM Treasury to improve transparency around assumptions for current discretionary spending in the later years of the forecast are welcome and will help increase scrutiny and communicate risks more clearly (OBR, 2024[33]), but more could be done. The Office for Budget Responsibility could account for the government’s revealed preferences to test the realism of baseline projections, as already done for fuel duty. With the backing of the Treasury Select Committee, this approach could be extended to other areas, such as planned cuts to central administration budgets.
1.4.4. Long-term spending pressures must be addressed to preserve fiscal space
Beyond the short- and medium-term fiscal outlook, significant long-term spending pressures will weigh on the sustainability of public finances. These pressures are primarily driven by ageing, which is projected to lead to one of the largest increases in health and long-term care expenditure in the OECD, estimated at about 2% of potential GDP by 2060, alongside rising and uncertain cost of state pensions due to the triple lock (Chapter 2). Additional non-demographic pressures will compound these trends. The fiscal cost of climate change mitigation is estimated at close to 1% of 2025 GDP annually until 2050, with lost revenue accounting for about two-thirds of the total, mainly due to the trend decline in fuel duty receipts (Chapter 3). Defence spending is also scheduled to rise by around 0.8% of GDP by 2035. Finally, the high level of public debt and higher gilt yields imply structurally elevated debt‑servicing costs.
Under current policies, public debt is projected to be unsustainable over the long term. Plans set out in the medium‑term fiscal strategy help to reduce debt only temporarily. In the absence of policy changes and considering ageing costs and climate damage, general government gross debt as a share of GDP would begin to rise from the mid‑2030s onwards, reaching close to 200% by 2050 (Figure 1.9, Panel A, red line). This is despite important measures announced by the government, including the planned introduction of the electric vehicle excise duty (eVED) in April 2028, a key step in the direction of offsetting the shrinking of the fuel duty tax base.
Note: The “Current policies” scenario assumes existing and planned spending and tax policies. The “Fiscal reforms” scenario assumes the implementation of fiscal recommendations listed in Table 1.5. The “Fiscal and structural reforms” scenario further assumes the structural reforms listed in Table 1.1. The sensitivity analysis assumes the implementation of fiscal recommendations listed in Table 1.4 except the reform of the triple lock, the phasing out of fossil fuel support and the indexation of duty freeze. Figures refer to the general government. All scenarios account for ageing costs.
Source: OECD calculations based on the OECD Long-Term Baseline (database); and OECD Long-Term Model.
A comprehensive package of fiscal and structural reforms could help to restore long-term sustainability while supporting potential output and productivity. It would include measures to both contain expenditure, especially health and pension spending (e.g., improving hospital efficiency, tightening access to disability benefits, and reforming the state pension triple lock), and strengthen revenue by broadening tax bases while limiting distortions (e.g., phasing out fossil fuel support measures, reducing the tax compliance gap and removing inefficient tax expenditure). With these fiscal reforms, the structural primary balance could improve by close to 2% of GDP over the medium term (Table 1.5), helping to contain the rise in the debt-to-GDP ratio (Figure 1.9, Panel A, blue line). Complementary structural reforms to boost labour supply, investment and productivity (Table 1.1) would further reinforce fiscal sustainability through higher growth and lower spending, and put public debt on a sustainable path (Figure 1.9, Panel A, green line).
Long-term fiscal projections are subject to significant uncertainty regarding the scale and timing of potential savings. Reforming the triple lock accounts for a significant share of the projected improvement in long-term debt dynamics (Figure 1.9, Panel B, long-dashed line) but such reform is politically difficult to implement and fiscal savings are highly sensitive to future volatility of consumer price inflation and earnings growth (Chapter 2). Efficiency gains in healthcare may also prove difficult to realise. In addition, reforms to phase out fossil fuel support might be politically unfeasible in the short term given the ongoing energy price shock (Figure 1.9, Panel B, short-dashed line). Moreover, these projections do not account for the additional public expenditure required for climate change adaptation (Chapter 3), owing to limited data availability and the absence of an analytical framework to link adaptation investments to reduced climate‑related damage costs (OBR, 2025[34]; Guillemette and Château, 2023[35]). These uncertainties underscore the importance of early and sustained policy action to strengthen fiscal resilience.
Estimated savings (+) and costs (-), % of GDP
Note: Estimates refer to the direct budgetary impact in the medium term (after 5-10 years) and the long term (10-25 years). Assumptions: (1) initially, 50% reduction in tax expenditure and in budgetary transfers, incl. reduced VAT rates on domestic fuel and power and indexation of fuel duty; then, gradual and partial offset of shrinking base with new taxes, incl. mileage charge; based on OECD Fossil Fuel Support database and on OBR data. (2) Short-term revenue of 0.1% of GDP, decreasing over time due to EV uptake and partly offset by rising mileage charge; based on OBR data. (3) 50% reduction in compliance gap for corporate income tax and for VAT; based on HRMC data. (4) Set threshold for relief such that forgone revenue is reduced by one third; based on HRMC data. (4) (5) Figure from OECD (2024). (6) 20% of model-implied savings on hospital spending; estimate from Barnes, Cournède and Hanmer (2025). (7) Estimate after 10 years, fiscal saving grows due to population ageing; see Chapter 2. (8) Estimate is +0.2; based on OECD (2024). (9) Estimate is -02; based on OBR (2025). (10) Reduce growth in spending on disability benefit to that of Universal Credit; based on OBR data. (11) Estimate below 0.05% of GDP. (12) Sum of gap between levy revenue and apprenticeship budget and two thirds of cost of new modules to universities; see Chapter 4. (13) Figure from OECD (2024). (14) Equivalent to a total R&D increase of 1% of GDP to OECD average; based on a crowding-in coefficient of 1.5 and OECD Main Science and Technology Indicators.
Source: OECD calculations.
1.4.5. Reforms to contain long-term spending pressures
Containing long-term spending pressures will require reforms that both restrain spending growth and improve the efficiency of public spending. With tax revenues already at historically high levels, broad based tax increases would be difficult to sustain and could weigh on economic activity. Instead, safeguarding fiscal sustainability will depend on targeted spending restraint and efficiency-enhancing spending reallocation across government functions. In this context, strengthening efficiency in areas where spending is relatively high (Figure 1.10), and better targeting welfare programmes will be key to containing spending pressures while preserving the quality of public services.
Government spending by function, 2024, % of GDP
Note: OECD refers to the average of the latest outturns by function for countries with available data.
Source: OECD Annual Government Expenditure by Function (COFOG) (database).
Containing welfare spending
Welfare spending accounts for 11% of GDP and has increased significantly since the pandemic and is projected to continue rising faster than nominal GDP. Spending on health and disability benefits has become a major driver of welfare expenditure growth. While part of this reflects the high incidence of self-reported disability (Figure 1.11, Panel A), cross-country comparisons suggest that programme design and incentives also play an important role. Gaps in activation requirements and higher benefit levels relative to unemployment benefits create incentives to claim and maintain long-term incapacity status. Strengthening the eligibility assessment framework for health-related benefits (Chapter 2), alongside improved activation and skills support (Chapter 4) would help ensure adequate support while containing fiscal pressures.
A related and fast‑growing component of spending pressures arises from special educational needs and disabilities (SEND). The share of children and young people requiring special schools (a so-called “education, health and care plan”), has doubled over the past decade, creating significant cost pressures for local authorities and leading the central government to fully fund it from FY2028-29 (Chapter 4). Central government funding is a welcome development, but further action is needed. Without reform, spending on special education support is expected to continue rising, potentially crowding out resources for mainstream education. Improving the effectiveness of support and strengthening accountability for outcomes would help ensure that students receive appropriate support while containing costs. The government recently published a white paper laying out its plan to reform the SEND system (HM Government, 2026[36]).
Expanding state capacity in special education could deliver savings over the long term. Limited availability of state-funded places has led local authorities to depend on the private sector (so-called “independent special schools”), which often operate at significantly higher cost (Farquharson et al., 2026[37]). Building more state-funded special schools would help and is possible under the fiscal rules, which preserve capital expenditure. At the same time, as much of the increase in assessed needs reflects greater awareness and lower diagnostic thresholds (Latimer, Sibieta and Snape, 2025[38]), adequate gatekeeping of special education support is essential to both contain costs and ensure that pupils with special needs achieve better outcomes.
Note: Panel A refers to averages over 2016-2019; OECD is the average of 32 countries with available data; see source for details. Panel B refers to positive deviations from model-implied spending by function of government, conditional on income per capita, age structure, total public expenditure and function-specific controls (including the share of private health expenditure); estimates smaller than one standard deviation are not reported; see Barnes, Cournède and Hanmer (2025[39]) for details.
Source: OECD (2022[40]) Disability, Work and Inclusion: Mainstreaming in All Policies and Practices; and Barnes, Cournède and Hanmer (2025[39]) “Assessing government spending in OECD countries and searching for savings”.
Improving public sector efficiency
Improving public sector efficiency will be essential to contain spending pressures while maintaining the quality of public services. The government has announced plans to increase public sector productivity by 5% by FY2028-29, through efficiency gains in the delivery of public services and reductions in central administration budgets (HMT, 2025[41]). Advances in digital technologies, including artificial intelligence and telework, offer new opportunities to improve service delivery and administrative processes.
Productivity improvements should focus on areas where there is clear scope for efficiency gains rather than relying on uniform spending cuts across departments. Even though the Spending Review 2025 includes bespoke efficiency targets for each department, across-the-board reductions in administrative budgets, as currently planned, risk undermining service quality and ultimately prove counterproductive. Instead, reforms should be guided by careful assessment of departmental responsibilities, operational needs and past efficiency improvements. This would contribute to preserving service quality, and ensure that departments with expanding programmes, such as the Ministry of Defence, do not face disproportionate reductions. Strengthening co-ordination across departments and continuing efforts to improve the measurement of public sector productivity would also help identify opportunities for efficiency gains.
Healthcare will play a central role in containing long-term spending pressures. Health and long-term care account for a large share of public expenditure and cost pressures are set to increase with population ageing, rising demand for services, and more expensive medical technology. As two thirds of planned productivity gains are expected to come from the National Health Service (HMT, 2025[41]), improving efficiency is therefore essential.
International comparisons suggest that spending in hospitals is particularly high in international comparison. Cross‑country OECD analysis shows that UK hospital spending is significantly above model‑implied benchmarks, even after accounting for income, age structure, total public expenditure and private health‑spending shares (Figure 1.11, Panel B). Moreover, hospital productivity remains below pre-pandemic levels (Harvey-Rich and Warner, 2025[42]). This indicates that there may be scope to improve the efficiency of hospital operations. Operational improvements could include better co-ordination of patient discharges, at the right time to the right location, especially as capacity is constrained in out-of-hospital care (Nuffield Trust, 2025[43]). Moreover, there is room for achieving savings in non-core areas, especially local social and community care (DHSC, 2024[44]), where the National Health Service has been increasingly involved to close gaps in local public services over the 2010s (Chapter 4).
Exercising prudence is key when searching for savings in the administration of health and social care. Untargeted cuts to administrative budgets could have detrimental knock-on effects on healthcare productivity, as the efficient delivery of front-line services depends on administrative quality. Maintaining adequate administrative capacity is essential for central procurement of drugs and equipment, effective management of large capital projects and overall system performance.
1.4.6. Higher tax efficiency would raise growth potential and support fiscal sustainability
Strengthening tax efficiency can complement efforts to contain spending pressures and support not only fiscal sustainability, but also growth potential. Tax revenues are already high by historical standards, limiting the scope for broad-based tax increases. The current tax structure appears balanced and relatively conducive to growth in international comparison, with relatively low revenue from corporate income taxes and social security contributions, average revenue from indirect taxes, and high revenue from property taxes (Figure 1.12). Continuing to improve compliance gaps, reducing distortions and broadening tax bases would therefore help to raise revenue, while supporting economic efficiency and growth, as discussed in previous Economic Surveys (OECD, 2024[9]; 2022[27]; 2020[28]).
Tax revenue by source, 2024, % of GDP
Note: Category “social security contributions” includes taxes on payroll and workforce; category “other taxes” includes sources unallocatable between taxes on income, profits and capital gains of individual and corporations; G7* and OECD average the latest available outturns by source; G7* refers to the average of G7 member countries excluding the United Kingdom.
Source: OECD Global Revenue Statistics (database).
Improving tax compliance
The gap between tax collected and theoretical tax liabilities remains significant at about 1.5% of GDP (Figure 1.13, Panel A). This reflects a two-fold increase in the corporation tax gap, from about 0.25% to about 0.5% of GDP, entirely driven by the increase in uncollected tax liabilities from small firms (Figure 1.13, Panel B). This partially offsets the marked improvement in VAT collection over the past decade, which was due to the decline in cash transactions and a set of policy measures to bolster collection. In addition, the flow of tax debt at about 3% of GDP in FY2023-24 more than doubled since the pandemic (HMRC, 2025).
Note: Figures refer to the gap between tax collected and theoretical tax liabilities.
Source: HM Revenue & Customs, OECD Economic Outlook: Statistics and Projections (database); and OECD calculations.
The government rightly increased resources for tackling non-compliance and debt collection as part of its tax plans, with several measures designed to narrow the corporate tax gap. New measures, including additional staff, more frequent recourse to private debt collection agencies, higher interest rates on tax debt and reforms to reduce fraudulent activities, specifically address non-compliance from SMEs and are expected to bring 0.2-0.3% of GDP in net revenue by FY2029-30 (OBR, 2025[45]; 2025[46]; 2024[29]).
Swiftly implementing announced anti-non-compliance measures for small businesses should be a priority, but improving the design of the tax system is also needed to supplement enforcement activities. Parts of the tax system are overly complex, entailing large compliance costs and increasing the likelihood of error or diverging legal interpretation, especially for small businesses. Moreover, significant tax differences across legal forms of income create incentives for tax-motivated incorporation (Adam, Delestre and Miller, 2025[47]). This tends to increase the number of people working through companies, with typically more complex tax liabilities than under the employee pay-as-you-earn system.
Broadening tax bases
Inefficiencies in the tax system partly stem from relatively large tax expenditures in international comparison (Figure 1.14, Panel A), which tend to reduce tax bases and weigh on revenue. Distortions generally arise from the hundreds of so-called “non-structural” tax reliefs, which are designed to advance specific economic or social objectives. A list of all existing non-structural reliefs is updated annually, with stated objectives and estimated costs where available. In its 2026 report, HM Revenue & Customs listed close to 300 non-structural tax reliefs, accounting for about 7% of GDP (HMRC, 2026).
Evolving current costing exercises into full-fledged reviews of tax expenditures would help identify scope for both fiscal savings and efficiency improvements. At minimum, such reviews should go beyond mere cost estimates under the current HMRC Evaluation Framework and assess non-structural reliefs against their stated objective, additionality and cost efficiency, as is done in several OECD countries including Canada and the Netherlands. Integrating these assessments into the budget process, as in Canada and France (Box 1.5), would increase transparency and facilitate the phase-out of reliefs that either run counter to overarching government objectives, have limited impact or could be delivered at lower cost. More ambitious and systematic value-for-money evaluations could be envisaged, including an assessment of distortions and distributional issues. These could be based on the expertise of the National Audit Office, subject to adequate resourcing.
Tax expenditures tend to be easier to introduce, harder to control and less likely to be subjected to scrutiny than direct spending (OECD, 2025[48]). Therefore, regular reviews are key to improving transparency, ensuring policy effectiveness and helping governments identify inefficient or poorly targeted tax relief.
In France, tax expenditures are reported by policy objective within the budget process, as an annex to the finance bill prepared by the Ministry of Economy and Finance. This contributes to stronger oversight by parliament and other institutions.
In Canada, the federal government’s annual Tax Expenditures and Evaluations report prepared by the Department of Finance Canada not only provides cost reporting, but also in-depth evaluations assessing the policy rationale, distributional effects and effectiveness in achieving stated objectives of selected measures. This helps to compare the costs and benefits of different tax expenditures and with direct spending programmes.
Source: OECD (2025[48]), Quality Budget Institutions.
Strengthening efforts to reduce distortions, close loopholes and make the system fairer remains necessary. A comprehensive tax review could help, as recommended in the last Economic Survey (OECD, 2024[9]). Priority areas for reform include:
Eliminating some reduced VAT rates. Lower (5%) rates, zero rates and exemptions from the headline 20% rate weigh on the yield of value-added taxation, which accounts for a third of non-structural tax reliefs (HMRC, 2026). The VAT revenue ratio is particularly low in international comparison, reflecting not only revenue lost to reduced rates, but also fraud and non-compliance (Figure 1.14, Panel B). Although lower VAT rates are often justified on distributional grounds, as they apply in part to goods and services consumed disproportionately by lower-income households, they are ill-targeted tools for redistribution. Moreover, lower rates distort consumption decisions and entail large social costs, as is especially the case for the lower rate on domestic energy consumption.
Updating council tax and abolishing stamp duty land tax. Although property taxation accounts for a relatively large share of total revenue, room for efficiency improvements is substantial (Chapter 4). Council tax (the local tax on domestic property determined by valuation bands) is still based on 1991 values. Updating property valuation and adjusting bands as recommended in previous surveys is long overdue (OECD, 2024[9]; 2022[27]; 2020[28]). Consequences for local public finances must be carefully monitored (Chapter 4).
Simplifying the personal income tax system. The income tax schedule features many arbitrary kink points, disparities across legal form and other complexities that distort labour supply. Priority reforms, discussed in depth in the last Economic Survey (OECD, 2024[9]), include further efforts to abolish the high-income child benefit charge and to align national insurance contributions for employees and the self-employed (Table 1.6).
Source: Global Tax Expenditure Database; and OECD (2024[49]) Consumption Tax Trends 2024.
Preparing a comprehensive medium-term reform of the corporate tax system should also be considered, with a clear emphasis on predictability and along the lines of the in-depth discussion in the last Economic Survey (OECD, 2024[9]). Reforms and stability should be carefully balanced, given the importance of certainty for business investment decisions. Thus, it is sensible for the government to start preparatory work while respecting its commitment to leave most the current system of corporate tax reliefs unchanged (HMT, 2024[50]), despite significant inefficiencies. Key reforms include, but are not limited to:
Attenuating biases in the corporate income tax system. The corporate tax system distorts investment decisions towards certain types of assets and funding decisions towards debt. Reducing the deductibility of interest against corporate income tax and broadening qualifying asset class for full expensing is necessary to attenuate these distortions (Table 1.6).
Ensuring the additionality of R&D tax credits and patent box. The R&D tax regime is generous in international comparison and implies a large marginal tax subsidy on R&D activity (Figure 1.15, Panels A and B). Moreover, recent reforms to contain the rising cost of R&D tax credits for SMEs rebalanced overall support towards large firms (NAO, 2024[51]), which tend to have routine R&D activities that are less responsive at the margin. Capping the value of the tax credit, like in Canada, would contribute to limiting windfall gains for large companies, subject to a new evaluation of additionality under the current system (Chapter 4).
Further reviewing costly and distortionary tax reliefs remains important, despite political constraints due to capture by specific groups who benefit disproportionately. Potential reforms include, among others:
Removing reliefs for homeownership and/or construction that do not increase housing supply. The private residence relief, which exempts the sale of the main home from capital gains tax, costs about 1% of GDP in foregone revenue (HMRC, 2026) with little evidence of impact on transaction volumes. Zero-rate VAT on the construction of new homes costs about 0.5% of GDP (HMRC, 2026) but risks merely boosting prices as supply is constrained, worsening affordability issues.
Streamlining the business property taxation system. Business rates based on estimated rental value discourage investment, while frequent changes to reliefs create complexity. Moving to a land value tax would provide better development incentives, as discussed in the last Economic Survey (OECD, 2024[9]).
Source: OECD Corporate Tax Statistics Database; and OECD R&D Tax Incentives Database.
Exercising prudence with tax increases
In case raising taxes becomes a last-resort necessity, carefully assessing behavioural responses and the broader context is key to minimising detrimental effects on efficiency and inequality (Cournède, Fournier and Hoeller, 2018[52]). The most straightforward option to yield large additional tax revenue consists of implementing a small rate increase on a large base, namely income tax, national insurance contributions or VAT. Raising other taxes would have particularly damaging effects on growth and welfare due to inefficient tax bases and strong behavioural responses (Adam, Delestre and Miller, 2025[47]).
Further raising national insurance contributions should be avoided, due to particularly detrimental labour supply effects and as the recent increase already pushed up labour costs. Raising income tax would in principle be less distortive for the same additional revenue, but the stealth effect of frozen thresholds has effectively increased income tax already. In addition, there is little room for straightforward progressivity adjustments, as taxation is relatively low for middle earners by design, while a relatively small number of taxpayers at the top of the income distribution account for a large share of revenue (Adam, Miller and Upton, 2024[53]). Thus, raising VAT seems the most prudent option.
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