Inflation forecast: where are prices heading next?

After peaking at 11.1% in October 2022, the rate of UK inflation has been slowing and household budgets are under less pressure than they once were.

The Consumer Prices Index fell below the Bank of England’s 2% target in September for the first time in over three years, prompting hopes of an interest rate cut when the Monetary Policy Committee (MPC) next meets on 7 November.

The cost-of-living crisis is not yet over, though. While the headline rate of inflation is now 1.7%, core and services inflation remain significantly higher at 3.2% and 4.9% respectively.

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Furthermore, the average energy bill surged by 10% from 1 October, and there are fears that the conflict in the Middle East could cause another energy shock.

Against this backdrop, you might be wondering where prices are heading next. We take a closer look at the latest forecasts.

Will inflation stay on a downward path?

The Office for Budget Responsibility (OBR) published an updated economic and fiscal outlook last week to accompany Rachel Reeves’s Autumn Budget. This included inflation forecasts for the next five years.

Inflation (as measured by the Consumer Prices Index) is expected to average 2.5% this year and 2.6% in 2025. It should then fall to 2.3% in 2026, 2.1% in 2027, 2.1% in 2028 and 2% in 2029.

Nearer term, there are likely to be some fluctuations from month to month, though. For example, although inflation slowed to 1.7% on an annual basis in September, it is expected to pick up again in October’s report (due on 20 November).

“Energy prices will inflate our spending horribly, because the energy price cap soared 10% at the start of October,” says Sarah Coles, head of personal finance at Hargreaves Lansdown. “When measured against a fall a year earlier, it’s going to look particularly grim.”

She adds that petrol prices are likely to add insult to injury. “They’ll be back on an upwards trajectory thanks to conflict in the Middle East and rising oil prices.”

Is the Autumn Budget inflationary?

Longer term, the latest government policies unveiled in the Autumn Budget add another factor to the mix.

In her fiscal statement, Reeves announced plans to increase government spending by £70 billion annually in an attempt to avoid cuts to public services and to fund investment projects.

She also unveiled £40 billion in tax hikes, with a large part of this being funded by an increase in employer National Insurance contributions (NICs).

Businesses will also need to pay employees a higher National Living Wage from April next year.

These policies are not expected to knock inflation off its downward trajectory, but they could impact the speed at which it takes place.

The experts at consultancy Capital Economics were previously expecting inflation to average out at 2.6% in 2025 and 2% in 2026. They have now adjusted these forecasts upwards slightly to 2.8% and 2.1% respectively.

Chief UK economist Paul Dales told MoneyWeek that this higher forecast is a result of two developments.

He says: “First, a bigger rise in the minimum wage than we expected [...] will mean that wage growth is a bit higher than otherwise, and we suspect that businesses will pass on some of that extra cost in higher prices.

“Second, the increases in government spending and investment announced in the Budget are taking place at a time when the economy is already operating close to capacity.

“In that situation, the faster rates of GDP growth we expect in light of the Budget will probably spill over into larger rises in prices than we previously thought.

“In short, the Budget won’t reignite inflation. But it will keep it a little hotter for a little longer than previously looked likely.”