UK inflation forecast: where are prices heading next?
Experts have revised their inflation expectations for 2026 due to the Middle East conflict. What’s next for prices?
UK inflation slowed in June, but experts warn that inflation is still expected to rise this year due to the economic consequences of the Iran war.
Inflation was 2.6% in the year to June, dipping from the 2.8% it was in May, according to the latest data from the Office for National Statistics (ONS). A dip this large was mostly unexpected by economists.
The easing of inflation last month was driven by motor fuel prices, which dipped when oil prices fell as the US-Iran war paused. However, fuel prices have since started to rise again after hostilities resumed.
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Another major factor in June’s lower inflation reading was the lowest food inflation since August 2024. Food and non-alcoholic drink prices rose by just 1.7% in the 12 months to June.
Where could inflation go next?
Since 28 February, the Iran war has consistently disrupted global trade, leading to price increases.
One particularly damaging issue is the closing of the Strait of Hormuz, a narrow waterway between Iran and Oman through which around 20% of the world’s oil and gas is transported. This means some ships have now been stuck in the strait for almost half a year.
As the strait has shut off a large proportion of the oil and gas supply, oil prices have surged, impacting motor fuel and heating oil prices. As oil is used in the production of a significant portion of the things we use and buy every day, price shocks will likely be felt more widely.
As long as the Iran war continues, prices are expected to remain high.
Meanwhile, the energy market is also under pressure because of the war, pushing up the cost of energy for millions of households and businesses in the UK.
The Ofgem energy price cap, which dictates the maximum a supplier can charge for a unit of energy, rose at the start of July, putting the average annual household bill for a dual-fuel family on the price cap at £1,862, when paying by direct debit. This is expected to rise in October to around £1,906 per year.
The price cap reflects the increased wholesale price of energy due to the war.
The UK is particularly sensitive to the wholesale energy market because it is a net importer of energy from overseas, meaning it is left at the whim of the market to set prices.
Moreover, even firms that do not produce goods derived from oil and gas markets will likely need to hike prices as the costs associated with running the business (such as energy bills and transportation costs) are still exposed to those markets. These costs will likely be passed on to the consumer.
Where do experts think inflation will go?
Most economists think inflation will remain above the Bank of England’s target for the rest of 2026.
The latest forecast from the Bank of England, published on 18 June, shows inflation is expected to stay just under 3% for most of 2026 before rising to a “little over” 3.25% in the final quarter of the year.
This latest prediction is significantly better than the central bank’s forecast in April, which said prices could peak at 3.6% this year in the best-case scenario or 6.2% in their worst-case scenario.
Deutsche Bank also expects inflation to rise in 2026. The bank believes inflation will peak at between 3.3% and 3.5% in the final quarter of 2026.
Sanjay Raja, chief UK economist at Deutsche Bank, said: “The good news is that inflation continues to miss expectations, coming in softer than most forecasters expected. The bad news is that the resurgence in commodity prices (energy, fertiliser) will keep inflation forecasts elevated for some time.”
The average forecast from economists surveyed by the Treasury on 17 June is that inflation will rise to 3.7% in the final quarter of 2026. By Q4 2027, they expect inflation will average 2.3%.
While inflation forecasts are less dire today than they were in March when the Iran war was starting, all forecasts still show that inflation is expected to remain above the 2% target for all of 2026 and some of 2027.
What’s the link between inflation and interest rates?
Inflation above the 2% target is always a cause for concern for economists, policymakers and consumers.
The Bank of England is particularly focused on inflation, as it has a remit to ensure prices do not spiral out of control.
This is largely done through setting interest rates, which are typically raised to fight inflation.
The trade-off to fighting inflation with higher interest rates is reduced economic activity. When interest rates are high, people have to use more of their earnings on expenses like their mortgage and are incentivised to save their cash as savings rates tend to be higher.
What does the inflation outlook mean for future interest rate cuts?
With inflation expected to stay significantly above the Bank of England’s target, interest rates are unlikely to be cut any time soon.
On 18 June, it was confirmed the Monetary Policy Committee (MPC) had held interest rates at 3.75% for the fourth consecutive meeting. The motion passed by seven to two.
The two members who did not vote with the majority (Huw Pill and Megan Greene) called for a rate hike to 4% as a preventative measure against the potential for more severe second-order inflationary effects.
This move was in line with most forecasts by economists, and experts believe that interest rates will stay at 3.75% until at least early 2027.
While many commentators have worried that the inflationary impact of the war means the MPC will need to hike interest rates, the latest set of inflation data makes this case weaker.
Raja at Deutsche Bank said: “Today’s inflation data will buy the MPC more time as it deliberates on where to peg monetary policy.”
However, the Bank is still unlikely to lower rates for some time. Raja explained: “The UK will see inflation push higher from here as base effects, food price rises and energy price rises catch up with households. This, we think, will continue to keep any prospect of rate cuts off the table for now, while allowing the MPC to retain its slight hawkish bias.”
Deutsche Bank believes that the first time we could potentially see a rate cut on the table again is spring 2027. Meanwhile, Oxford Economics believes that the first cut may be seen in late 2027.
For more on the future of interest rates, read our article on where interest rates will go next.
