Further interest rate cuts expected amid persistent inflation and rise in unemployment 

The EY ITEM Club predicts that inflation will remain above 3% for the second half of this year and average 3.4% across 2025, up from expectations of 3% in April’s Spring Forecast. This is likely to be driven by a rise in household energy bills, as well as increases to the National Living Wage and employers’ National Insurance Contributions, which are expected to keep labour costs elevated even as pay growth cools later in the year. 

Headline inflation is then expected to fall back to 2.6% next year before reaching the Bank of England’s 2% target in the second half of 2026 as looser labour market conditions and softer wage growth cause services inflation to slow. 

The unemployment rate is forecast to rise from 4.7% to 5% by the end of 2025, before falling back to around 4.5% by the end of 2027. This small temporary increase is expected to be driven in part by elevated labour costs, which are anticipated to cause hiring to slow. 

Rising unemployment is set to drive a further slowdown in earnings this year, with pay growth forecast to fall back to around 3.5% by the end of 2025 and 3% by the second half of 2026. 

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “The number of employed people across the UK has fallen in recent months and the jobs market is expected to continue its slowdown into next year as businesses contend with weak economic growth and increases in the National Living Wage and employers’ National Insurance Contributions. However, the rise in unemployment is expected to be relatively modest, with a slowdown in hiring more likely than largescale layoffs.

“Nevertheless, the UK’s economic position remains challenging and tightening fiscal policy and the lagged effect of interest rates, with some households still due to refinance their low-rate fixed mortgages in the coming year, will restrain growth. US tariffs, high bond yields and recent changes to welfare legislation will have increased spending and reduced tax revenues, shrinking the Government’s already-thin fiscal headroom. This challenge could be even more significant if the Office for Budget Responsibility downgrades its growth assumptions at the Autumn Budget, or if the Government is required to accelerate defence spending before the end of this parliament.”

Steady interest rate cuts expected into 2026

Weak GDP growth, rising unemployment and cooling pay growth are expected to provide the Monetary Policy Committee (MPC) with sufficient evidence to maintain its cut-hold pattern on interest rates in the near term. The EY ITEM Club predicts two further 25 basis point cuts to the Bank Rate in 2025, with one in August and another in November, followed by a further cut in February 2026. This would leave Bank Rate at 3.50% in 2026, where it is expected to remain in the near term.

A steady fall in interest rates should support a gradual rise in business investment later in 2026 as companies see debt servicing costs decline and have more money to put towards expenditure. However, these service costs will still remain higher than the levels seen between 2010 and 2019, limiting the growth of business investment. 

Matt Swannell, Chief Economic Advisor to the EY ITEM Club, said: “While the MPC appears more concerned about cutting interest rates too quickly rather than too slowly, a softening job market and cooling pay growth should provide reassurance that domestic inflationary pressures are set to fade, albeit gradually. We’re likely to see interest rates cut again in August as the Committee maintains its pace of one 25bps cut per quarter.”

Consumer spending expected to lift in 2026 as house price growth slows

According to the forecast, slowing real income growth, economic uncertainty and subsequent consumer caution are likely to limit consumer spending to 0.9% growth this year. However, household spending is then predicted to grow to 1.1% in 2026 as consumer confidence increases, which should support UK GDP growth in 2026 as business investment stalls. 

House prices are expected to see 3.5% growth this year, before falling to 2.5% in 2026. Planning reform and a steady fall in interest rates are expected to support housing market activity, although this is expected to be counterbalanced by elevated construction costs and labour market shortages, limiting the pace of housebuilding.