The coming year will be a tougher one for the UK economy after a step-up in growth in 2025.
A large fiscal contraction combined with weak consumer confidence and sagging business sentiment means we expect growth of only 0.8% in 2026.
But inflation should slow markedly to finish the year around 2.5%, down from 3.8% at the end of 2025. At the same time, interest rates should drop to between 3% and 3.5% by the end of the year.
Three main factors will weigh on inflation in 2026:
- Base effects: First, the base effects of the 2024 tax and duty hikes, which pushed up inflation last year, will fade as they fall out of the year-over-year comparison in April.
- Fiscal policies: Second, the measures announced in the budget, like reducing the value-added tax on energy bills, will put downward pressure on inflation.
- Tax increases: Finally, the big increase in personal taxes this year will reduce demand in the economy and increase the size of the output gap—the difference between potential and actual gross domestic product—which will put further downward pressure on inflation.
This economic weakness means that the unemployment rate will probably continue to creep up, reaching a little above 5% early next year, before starting to fall in the second half of the year as the labor market adjusts to previous increases in employment taxes and regulation.
That rise suggests a loosening but not a loose labor market, especially when compared to the 8% peak in unemployment after the global financial crisis of 2007−09.
Still, a looser labor market and sharp slowdown in inflation suggest that pay growth will also slow. We expect it to decline from almost 5% to closer to 3.5% by the end of 2026.
The combination of a loosening labor market, slower pay growth and lower inflation will allow the Bank of England to cut interest rates in December and potentially twice more next year, taking rates to 3.25%.
Read more insights on the British and Irish economies from RSM UK’s economists.
The good news is that the household saving ratio, at above 10%, is extremely high. That robust rate means households can offset some of the hit to their incomes from higher taxes by saving a slightly lower proportion of their income.
What’s more, financial conditions are accommodative, and lower interest rates will blunt the incentive to save, helping to bring down the saving ratio.
Ultimately, contractionary fiscal policy means that growth will probably fall from 1.5% in 2025 to a little below 1% in 2026.
But the outlook is considerably better for 2027. By the end of 2026, inflation should be back to almost 2%, interest rates will be only a fraction above 3%, and gilt—government bond—yields are likely to have come down further.
Those trends should set the stage for a recovery in consumer spending and business activity, especially if the public finances appear in better shape and the threat of further tax rises has receded.
The short-term outlook is painful, but there is hope on the horizon.
Source: UK Office for National Statistics, RSM UK
Ireland: Robust growth, but supply constraints bite
The Irish economy has proven remarkably resilient throughout 2025 despite the headwinds from U.S. tariffs, which will hit Ireland harder than the rest of Europe.
Admittedly, the first estimate of gross domestic product for the third quarter suggested the economy shrank marginally, but we think it remains on track for GDP growth of well over 10% in 2025 and domestic growth of around 3% in 2025.
But growth will probably slow in 2026 as the impact of tariffs and global political uncertainty take a toll and supply constraints start to bite.
Still, growth in 2026 will probably register another solid performance as another big increase in government spending provides a tailwind to the economy. That should lead to domestic growth of around 2.3%.
The economy, though, has reached the point where growth will be increasingly limited by supply-side challenges like a tight labor market and infrastructure constraints, especially on housing.
For this reason, we think growth will slow over the next few years toward a trend rate of around 2% to 2.5% after an exceptionally strong period.
The recent rise in inflation to 2.7% should prove short-lived, as we expect inflation to average 2.2% in 2026, in large part thanks to a strong euro, which will continue to make imported goods more affordable.
On the domestic front, we are less confident that inflationary pressures will subside. Strong domestic demand, infrastructure shortages and a tight labor market mean services inflation is likely to remain around 3% next year.
All told, we expect the Irish economy to continue to outperform the rest of Europe throughout next year as strong population growth, government spending and wage growth prop up domestic demand.
