What will happen to UK interest rates in 2026?
The Bank of England’s Monetary Policy Committee held interest rates for the fifth consecutive time in July. With the inflation expected to rise, where will interest rates go next?
Interest rates are expected to remain at 3.75% for the rest of this year as policymakers continue their ‘wait and see’ approach to monetary policy as the Iran war continues to disrupt the world economy.
In the latest Monetary Policy Committee (MPC) meeting on 30 July, interest rates were held for the fifth consecutive meeting, with the motion passing by six votes to three.
This action was widely predicted by economists as there is still significant uncertainty on global economic conditions with the Iran war continuing to disrupt oil and gas markets as well as wider trade through the Middle East.
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Though inflation has slowed or stayed the same since March, it is still expected to accelerate before the end of the year.
The Bank of England’s latest forecasts, published on 30 July, show inflation could hit 3.2% in the final quarter of the year.
Rising inflation is expected to come from higher energy and oil prices meaning interest rate cuts could be off the table for the time being.
How is inflation influencing interest rates?
The MPC uses economic data to help inform its interest rates decisions.
One of the most important economic metrics used by the MPC is the rate of inflation. This is because the Bank of England has a mandate to keep price growth under control.
The Bank’s inflation target, like that of most western central banks, is 2%, which economic consensus says is a healthy level of inflation in an economy that stimulates spending while keeping prices under control.
The main way the central bank works to achieve this goal is by increasing or decreasing interest rates.
Broadly speaking, when inflation is too high, the MPC will raise interest rates, and when it is too low it will lower them.
These are not the only two reasons why interest rates are moved, though. For example, rates might be lowered if economic growth is too slow, to help boost the economy.
Inflation is currently above the 2% target and has been for quite some time. The latest official inflation figures showed the Consumer Prices Index (CPI) dipped to 2.6% in the 12 months to June.
This was lower than forecast by most economists, and was in large part due to falling motor fuel prices after the Iran war paused. June also saw the lowest level of food and non-alcoholic drink inflation since August 2024 at 1.7%.
But despite the positive inflation figures in June, most economists expect inflation will accelerate over the course of 2026 as the UK economy contends with the inflationary shock caused by the Iran war.
And as inflation is set to remain above-target for the rest of 2026, it is unlikely that the Bank of England will decide the environment is right for an interest rate cut.
The rest of the economic background
Inflation is not the only data the MPC uses to make base rate decisions. Another key metric is the state of the labour market.
A softer labour market with higher unemployment and poor wage growth is a disinflationary pressure in the economy, while strong wage growth and full employment drives up inflation.
The latest set of labour market data, published on 21 July, showed unemployment held at 4.9% in the three months to May for the second month in a row..
At the same time, regular wage growth remained at a six-year low. Regular earnings held at 3.4% in the three months to May, rising to 4.3% when including bonuses.
This was led by the public sector, where wages grew by 5.5% in the three months to May while private sector earnings grew by just 2.9% in the same period.
Meanwhile, the UK economy grew by just 0.1% in the month to May, reversing a 0.1% drop in GDP in the month prior.
Will interest rates fall in 2026?
Between August 2024 and December 2025, the Bank of England cut interest rates six times – roughly once a quarter, and each time by 0.25 percentage points.
That cutting trend brought the base rate down from a recent high of 5.25% to 3.75% in December 2025.
Rates have remained on ice since then, with five consecutive meetings of the MPC deciding to keep rates at 3.75%, ending the roughly quarterly cadence of rate cuts we saw since the summer of 2024.
While geopolitics is one of the key reasons the MPC is keeping rates at 3.75%, economists had already been doubting whether quarterly rate hikes would continue in 2026, speculating that interest rates were getting closer to the UK economy’s neutral rate of interest.
Now, with forecasts showing inflation is expected to rise to 3.2% by the end of the year, most economists think the MPC will keep rates where they are for some time.
This being said, there is a chance that interest rates could be hiked. In the latest MPC meeting, three members voted to raise rates to 4%, up from two in the previous meeting and just one in the meeting before that.
It shows there is a growing faction in the MPC who believe the best move is to hike interest rates now as a precautionary measure against a worse inflationary shock than current forecasts show.
The next interest rates announcement will take place on 17 September.
Following the latest MPC meeting, Sanjay Raja, chief UK economist at Deutsche Bank, said: “We see no change in Bank Rate given the information we have today. But the outlook remains highly dependent on developments in the Middle East.
“The longer tensions in the Middle East continue, the higher the risk of a policy shift in the coming months. Indeed, should energy prices drift further, extending the duration of the price shock across energy futures, the balance of risks could quickly shift towards a tightening cycle as opposed to a protracted pause.”
Economics advisory firm Oxford Economics expects the MPC to hold rates at 3.75% until at least the start of 2027.
Andrew Goodwin, chief UK economist at the firm, said: “Members pointed out that this isn’t guaranteed to remain the case, but provided forward-looking indicators are benign, the majority think policy is already sufficiently restrictive.
“The MPC downplayed the extent to which the rising path in market rates implies tightening is likely, arguing that it mainly reflects risk premia rather than expectations that Bank Rate will rise.”
This being said, Goodwin warned: “The conflict in the Middle East is still the wildcard that could trigger a change of view. Several members suggested a sustained period of higher energy prices would raise the chances that second-round effects would develop.”
