Inflation will be below target by mid-2026, predicts the Bank of England

Inflation will be below the key two percent target in 2026 and 2027 – unless interest rate cuts are more drastic than expected – the Bank of England announced today.

The Bank's Monetary Policy Committee today voted 7-2 to keep interest rates at a 14-year high of 5.25%. Markets are hoping this will be the last hold before the Bank begins further rate cuts. At the same time as the decision, it published its latest forecasts for the UK economy.

The bank had previously expected inflation to briefly fall to target this quarter, before rising again and remaining above target until 2027.

It still expects inflation to fall to target this quarter, helped by the lower energy price cap and high food comparatives, but the longer-term forecast now suggests inflation is less entrenched. The Bank tends to look at longer-term signs of inflation rather than the short-term picture.

According to the bank's estimates, inflation is likely to reach 1.6 percent by the end of 2026. In its monetary policy report in February, the bank had forecast inflation of 2.0 percent for that time.

The bank has also upgraded the UK's growth outlook. Kathleen Brooks, head of research at XTB, called the combination of higher growth numbers and lower inflation numbers a “Goldilocks report.” “As expected, growth was revised upwards, while inflation for the UK was revised significantly downwards. The BOE no longer sees inflation in the UK below 3% over its forecast period, which extends to 2027. This is a big change for the UK and suggests that the UK's inflation problem is now under control and price pressures have eased sharply, even though the economy has reached near full employment. While the BOE believes it is too early to declare victory over the cost of living crisis, it also believes that key indicators of inflation persistence are weakening, helping to ensure that the overall disinflation trend continues.

“The BOE's unemployment forecasts have also been revised downwards, which could mean the UK economy is in for a soft landing of its own.”

The Bank of England's forecasts are based on market expectations for interest rates before its meeting. Markets had priced in two rate cuts before the end of the year and expected interest rates to remain high compared to the 2010s and to remain above 3% by 2027.

If the bank believes that inflation will be below its target if it continues on this path, it may be inclined to cut interest rates more aggressively than markets expect.