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. Where will interest rates go next?
The Bank of England should raise interest rates to 4% to protect households from inflation, the Bank’s chief economist Huw Pill has said.
Pill, who has voted to hike interest rates in the last three ratesetting committee meetings, warned the “wait and see” approach the Bank is currently taking will not stave off inflation if price growth is worse than the Bank’s current predictions.
He said the current approach of keeping rates at 3.75% means the Bank of England may fall “fall ‘behind-the-curve’ in addressing emerging inflationary risks” if the economic damage from the Iran war is more substantial than expected.
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The Bank of England’s Monetary Policy Committee (MPC) has held interest rates for the past five consecutive meetings. The latest of these was on 30 July, when the motion to hold passed by six votes to three.
The hold 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.
With the scale of the disruption from the war still yet to be fully seen, interest rates are unlikely to be cut this year.
But pressure to raise interest rates may also grow as inflation is predicted to rise in the remainder of the year. The Bank’s central projection expects price growth to peak at 3.2% in the final quarter of the year.
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. The latest official inflation figures showed the Consumer Prices Index (CPI) rose by 2.9% in the 12 months to July, up from 2.6% in the year to June.
The rise was widely forecast and marks the start of what is expected to be a period of accelerating inflation for at least the remainder of 2026 as the UK contends with the economic impact of the Iran war.
With inflation set to remain above 2% for the rest of the year, and possibly next year too, it is incredibly unlikely that the Bank of England will decide the economic 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 18 August, showed unemployment held at 4.9% in the three months to June for the third month in a row..
At the same time, regular wage growth was at a near-six-year low. Regular earnings held at 3.5% in the three months to June, rising to 4.1% when including bonuses.
This was led by the public sector, where wages grew by 6.1% in the three months to June while private sector earnings grew by just 2.8% in the same period.
Meanwhile, the UK economy grew by just 0.3% in the month to June, up from 0% growth 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 the MPC deciding to keep rates at 3.75% for five consecutive meetings.
While geopolitics is the key reason why, economists had already been doubting that 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 peak at 3.2% in the final quarter of 2026, most analysts think the MPC will keep rates frozen at 3.75% for some time.
This being said, there are a growing number of MPC members calling for a rate rise, steadily growing from just one in April, to two in June and three in July.
The dissenters argue the best move is to hike interest rates now as a precautionary measure against a worse inflationary shock than current forecasts show.
Despite this, it seems the economic data will help stave off a rate rise for the time being as although inflation is rising, the labour market has continued to be weak.
David Rees, head of global economics at Schroders said: "Persistent slack in the labour market leaves the UK better placed than most developed economies to avoid these shocks generating second-round inflation effects. That should allow the Bank of England to look through the near-term rise in inflation and continue to push back against market pricing for rate hikes."
The next interest rates announcement will take place on 17 September.
Following the July 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.”
