As a result of lower energy and food prices and weaker economic growth, the UK fiscal watchdog predicts that inflation will average 2.3% by 2026. This is lower than what was predicted in November.
It has nevertheless warned that an escalating Middle East conflict “could significantly impact the global economy and particularly the energy markets.”
The Office for Budget Responsibility, in its most recent economic and fiscal outlook said that consumer prices are projected to drop from an average 3.4% by 2025, to 2.3% on average in 2026 before stabilising around 2.0% in 2027.
The forecast for 2026 is 0.2% lower than the November prediction.
Rachel Reeves presented updated forecasts for inflation to Parliament on Tuesday. She said that readings were lower than anticipated in the last few months, and would likely fall near the Bank of England target by April.
Lower energy and wage prices reduce pressure
OBR attributes the improvement in inflation to “more slack” within the economy and lower food and energy prices.
The watchdog has noted that the average market expectation for gas prices has fallen 15% since November.
The slowing of wage growth will also contribute to the reduction in price.
The growth in nominal weekly wages is expected to moderate to 3.5% by 2026, and to average 2.5% per year thereafter. This roughly matches previous predictions.
This is due to the weakening of labour markets, declining inflation, and gradual transference of increases in National Insurance employer contributions from last year.
The OBR forecasted inflation at 2.5% for this year in November when Reeves presented her complete Budget.
Price data have been surprising to the lower side since then. This has provided some relief for the government after the long-lasting cost of living crisis.
Middle East Conflict clouds the outlook
The OBR has stressed the geopolitical risk remains acute despite the improvement in the near term.
Report warned of the potential impact on global economics, and particularly the energy market, if the conflict escalated in the Middle East.
Brent crude prices jumped by 6% on Monday amid concerns about supply disruptions. Benchmark European Gas Prices soared over 40%.
Before the forecast, economists warned that rising energy prices in global markets could undercut Reeves’s attempts to reduce inflation and boost growth.
Mujtaba Rahaman, a consultant with Eurasia Group said: “Just as Reeves thought the economy was on an even keel again, now the government faces a crisis outside of its control that creates a massive headwind.”
The two most important areas in the economy are interest rates and cost of living.
The growth forecast has been downgraded and unemployment is expected to peak by 2026
The growth forecast has weakened, despite the expected decline in inflation.
The real GDP will grow by 1,4% before slowing down to just 1.1% in the year 2026. This is a 0.3-point decrease from November’s projection.
This downgrade is due to weaker than expected output data for late 2025. It also reflects a further loosening of the labor market, and softer business surveys.
OBR stated that it viewed the weakening as cyclical and suggested that there would be more spare capacity than originally assumed in 2026.
The growth rate is expected to increase modestly, to 1,6%, in both 2027-2028. This will be slightly more than the earlier forecasts. It then declines to just 1.5%, in 2030 and 2029.
The unemployment rate is projected to reach a maximum of 5.3% by 2026, before falling gradually to an equilibrium of 4,1% in 2030.
Watchdog says labour market weakness is primarily due to newcomers struggling to get hired amid low hiring demand.
Simon Gleeson is a partner with Blick Rothenberg. He said that the government should not be focusing on growing unemployment and downgraded forecasts.
He said that she had chosen to focus more on her plan for the economy than the slowdown in growth near term.
Markets uneasy but borrowing improves
Forecasts showed that public borrowing would fall by nearly PS18bn compared to the Autumn Statement. This year’s borrowing will be at its lowest level in six years, and for the first 22-year period below the G7 Average.
The headroom for the stability rule of the government has increased by almost 24 billion PS.
The financial markets were jittery in response to the global events.
Normal circumstances would have allowed the government to lower its borrowing costs if November’s forecast showed that borrowing fell faster than expected.
Investors are uneasy about the Iran conflict, and energy prices have risen.
The yields on gilts of 10 years have increased by 16 basis points or 0.16 percent. This is a dramatic move.
The yields on two-year gilts have also increased by 16 basis point to 3.79%.
This post UK inflation to reach 2.3% by 2026: OBR warns of war energy risks appeared first on The ICD
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