UK inflation forecast: where are prices heading next?
UK inflation fell sharply in January, but with conflict in the Middle East threatening the British economy, will price growth fall further in 2026?
Experts fear the Iran war has scuppered hopes that inflation will return to the 2% target in 2026 as some forecasters now expect inflation to stay north of target until at least the end of this year.
The latest inflation data available shows inflation fell to 3% in the year to January 2026, down 0.4 percentage points from the previous month, as inflation continued its downward trend before war broke out.
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Where has inflation gone recently?
At the start of 2025, inflation fell close to the Bank of England’s 2% target but quickly rose to a high of 3.8% by July. Inflation stayed at this level between July and September, then fell in October and November.
But this trend of either plateauing or falling inflation was bucked in the final month of 2025, when December’s data showed price growth rose to 3.4%.
When it was released, January’s data seemed to support the case being made by many economists that inflation was going to sustainably fall through 2026, reaching the 2% target this year.
Before the conflict made forecasters adjust their predictions, all economists surveyed by the Treasury between 2 and 12 February agreed inflation would continue on an overall downward trend. The average inflation prediction among them for Q4 2026 was 2.2%.
However, as the economic impact of the Iran war has become clearer, experts have changed their predictions.
Where will inflation go next?
In the minutes of the most recent meeting of the Bank of England’s Monetary Policy Committee (MPC), the committee said they expect inflation to reach 3.5% in the third quarter of the year, as the new energy price cap is predicted to significantly increase average energy bills.
The minutes said: “Based on the oil and gas futures curves as of 16 March, Bank staff projections suggested that the direct contribution of energy prices to CPI inflation in 2026 Q3 would be around ¾ percentage points.”
They noted that higher energy prices will not only sting customers when paying their own bills, but that they expect firms to pass their own increased energy costs onto consumers.
A slightly more pessimistic forecast has been made by consultancy Oxford Economics, which sees inflation reach 4% again in the second half of the year before cooling in 2027. The lion’s share of the rise will come from increased petrol and energy prices.
Moreover, the firm expects a larger rise in inflation over the next year to hit economic growth, resulting in a more pronounced slowdown in activity growth.
Edward Allenby, senior economist at Oxford Economics, said: "Higher fuel and energy costs, as well as the upward pressure these will have on other prices, point to a greater squeeze on real household incomes.
“Therefore, we now project GDP growth of 0.4% this year and 1% next year, compared to our February baseline of 0.9% in 2026 and 1.3% in 2027, respectively."
Meanwhile, the Office for Budget Responsibility (OBR), the UK’s fiscal watchdog, warned the Iran war could have “very significant impacts on the global and UK economies”.
It added that inflation could end the year at around 3%, though this prediction was made on 10 March, before many of the economic consequences of the Iran war became more pronounced.
Why does war in Iran mean higher inflation in the UK?
UK inflation is likely to be affected by the war in the Middle East as prices will rise for products exposed to the oil markets. We have already seen this happen in some markets.
The price of petrol, for example, rose by 14.4p per litre between 28 February and 23 March, and the price of diesel increased by 28.8p per litre in the same period.
Households reliant on heating oil also face increased costs. The price of the fuel has more than doubled since the conflict began.
More price shocks could be on the way too as a significant proportion of the things we use and buy daily are derived from oil, or use it when they are being produced – this includes goods as varied as plastic, crayons, shoes, backpacks, iPhones, pillows, and much more.
As so many of the goods we consume are exposed to the oil market, fluctuations in the price of oil tend to have a significant effect on inflation. Broadly speaking, each $10 rise in the price of a barrel of oil typically translates into a 0.1 percentage point rise to CPI inflation.
The area where the UK is particularly exposed to economic shocks is in the increased price of wholesale energy, which manifests itself to consumers in the form of higher energy bills.
Energy consultancy Cornwall Insight said the energy price cap could rise by 20% in July if the conflict continues to wreak havoc on global energy supply lines.
The UK is so sensitive to the wholesale energy market because it is a net importer of energy from overseas, meaning we are 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 (energy bills, transportation costs, etc.) are still exposed to those markets. These costs will likely be passed on to the consumer.
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 influencing 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?
The Bank of England chose to hold interest rates at 3.75% at the most recent MPC meeting on 19 March.
The vote to hold was unanimous as members of the MPC agreed they would do everything in their power to protect the UK from increased inflation.
Before the most recent conflict in the Middle East, analysts expected the MPC to cut interest rates twice in 2026, with a 90% chance of a cut at the next MPC meeting on 19 March having been priced in by the markets.
However, the chances of this have dropped dramatically as the inflationary risk of the US-Iran war became clearer. Most economists no longer expect any more rate cuts in 2026, with the market even pricing in rate hikes.
Deutsche Bank does not think the Bank will cut rates at all in 2026, keeping the base rate at 3.75%.
Meanwhile, Oxford Economics is more pessimistic, expecting the MPC to keep interest rates where they are until well into 2027, with a cut potentially only on the cards by the end of next year.
