What will happen to interest rates and inflation in 2026

Most economists expect further cuts to rates this year with inflation set to fall

Inflation and interest rates are both set to fall this year, economists predict.

Inflation – the rate of price rises – currently sits at 3.2 per cent, but the Bank of England (BoE) has predicted it will fall well below 3 per cent in the first half of the year.

Interest rates, which have a large bearing on mortgages, generally go higher when inflation is above the BoE’s target.

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The BoE tends to lower the rate when inflation approaches its target, because higher interest rates are a tool to make borrowing more expensive and slow the rate of price rises.

Interest rates currently sit at 3.75 per cent after being lowered in December – but with inflation expected to fall, further reductions could be on the way.

What will happen to inflation this year?

Economic consensus is that the consumer prices index (CPI) measure of inflation will fall this year, partly as a result of November’s Budget, which raised taxes.

Some taxes can lower inflation because they put pressure on people’s disposable income, which means they have less money to spend on goods and services.

The BoE said in December: “Following the Budget announcements on administered prices and indirect taxes, headline inflation was now expected to fall back more quickly in April, to closer to 2 per cent.”

Raj Badiani, economics director at S&P Global Market Intelligence, said he expected inflation to end the year at 2.1 per cent.

“We expect the headline rate to stand at 2.1 per cent at the end of 2026 and be around the BoE’s 2 per cent target during the second half of 2026. We argue that the risks to inflation in the coming year are now on the downside,” he said.

Thomas Pugh, partner at RSM UK, said he thought inflation would reach a low point of 2.2 per cent next year.

But other forecasters do not expect inflation to get this low.

Pantheon Macroeconomics has forecast inflation to hit a low of 2.3 per cent in June, but end the year at 2.9 per cent.

What will happen to interest rates this year?

Most economists expect there to be at least one interest rate cut in 2026, taking rates to at least 3.5 per cent.

But some predict that there are multiple cuts ahead.

Sanjay Raja, chief UK economist at Deutsche Bank Research, said: “Big picture, the bank rate remains on a downward trajectory. We expected three things heading into the BoE’s final meeting of the year: one, a quarter-point rate cut; two, a 5-4 vote split and three, the MPC raising the bar for further rate cuts.

“Importantly, we expect the precipitous drop in CPI next year alongside a deteriorating labour market to keep quarterly rate cuts in play next year.

“We stick to our long-standing call of two more rate cuts in 2026: one in March, and one in June, taking bank rate to 3.25 per cent. Risks are skewed to a slower but deeper easing cycle.”

Below is what major economic forecasters are predicting for 2026.