UK inflation set to plunge

The UK has been running higher levels of inflation than the US or euro area for much of the last four years. Over the last year, prices rose in the UK by 3.4%, faster than in any other G7 economy.

Things are about to change. We expect inflation to drop like a stone in April, down to around 2.0%, at or near the Bank of England’s target rate.

Three factors are at work.

First, we expect a significant reduction in energy bills. Cuts announced in the November budget, alongside lower wholesale gas prices, are expected to reduce the Ofgem price cap by around 8% in April.

Second, regulated service prices, many of which are updated annually in April, are set to rise at a much slower pace than last year, reducing inflation. Last April’s 26% increase in water and sewerage bills, needed to fund investment, will fall out of the annual inflation numbers. So too will last year’s much smaller rise in vehicle duties, which will remain unchanged this April. Last March’s rail fare rises and last January’s VAT rise on private school fees will also fall out of inflation calculations by April.

Third, with agricultural commodities prices falling, we expect food price inflation, which has run well above general inflation in the last three years, to moderate.

This isn’t just about lower energy, food and regulated prices driving headline inflation down. Underlying, or core, inflation, which strips out food and energy, should also fall in coming months. Higher national insurance contributions, rises in the minimum wage and strong earnings growth seem to be taking their toll, with surveys of employers, including Deloitte’s CFO Survey, showing low levels of labour demand. The unemployment rate has risen from a low of 3.6% in mid-2022 to 5.1% and we see it peaking at 5.7% later this year. Earnings growth is likely to slow markedly this year, helping to push core inflation lower.

With inflation expected to hover between 2% and 2.5% for the rest of the year, real wages should keep rising throughout 2026. Much lower inflation creates room for further interest rate cuts. We expect two 25-basis-point cuts between now and autumn, taking the Bank Rate down to 3.25% – a significant reduction in borrowing costs for households and businesses.

Lower inflation and interest rates coupled with continuing growth in real pay are unalloyed good news for consumers. They might just mark the beginning of a broad-based recovery in consumer spending that has eluded the UK so far.