Monetary Policy Report - July 2026

Monetary Policy Overview

The situation in the Middle East is volatile and continuing to have a material effect on the outlook for UK inflation.

CPI inflation was 2.6% in June, above the MPC’s 2% target. There are clear signs that underlying price and wage pressures have continued to ease. But that has been offset by higher global energy prices as a result of the conflict in the Middle East, which have led to higher motor fuel prices for UK consumers.

Inflation is likely to rise over the rest of this year as higher global energy prices continue to feed through into UK consumer prices. That is due to a mix of the direct effects of higher global prices on household utility prices, and indirect effects, as companies at home and abroad pass on increases in their energy costs through supply chains.

The MPC cannot influence global energy prices. What the MPC is doing is setting monetary policy to make sure that the effects of the shock do not become embedded so that inflation falls back to the 2% target and stays there.

The MPC’s current approach to setting interest rates, including today’s decision, is based on two key judgements.

Key policy judgement 1

Weakness in economic activity and demand for labour is likely to help contain the strength of second-round effects from higher energy prices. But the outlook is uncertain and the risk of strong inflationary pressures continues to be greater than the risk of weak inflationary pressures.

The outlook for UK inflation continues to be shaped by two key uncertainties: the size and duration of the energy price shock; and how higher energy prices transmit through the economy, in particular whether they affect wage and price-setting behaviour and feed through into broad-based inflationary pressures – often referred to as second-round effects.

The size and duration of the energy price shock affects the strength of inflationary pressures through its direct and indirect effects. The more that the prices of oil, gas and refined energy products such as jet fuels and diesel rise, and the longer they stay high, the bigger the direct and indirect effects boosting inflation will be.

Second-round effects are also likely to be stronger the larger and more long-lasting the energy price shock is. For example, higher inflation arising from larger direct and indirect effects could feed through via higher inflation expectations into companies’ price-setting behaviour. Higher inflation could also make it more likely that workers will bargain for wage increases to maintain the purchasing power of their pay and that companies agree to those demands – which in turn would push up their costs and could lead them to raise prices by more. These interactions between the energy shock, inflation expectations, wages and prices would amplify the effects of higher energy prices on inflation.

As in April, the MPC continues to judge that weakness in economic activity and demand for labour is likely to help contain the strength of second-round effects, by limiting companies’ pricing power and workers’ ability to bargain for higher wages. This judgement is also supported by developments in broad money (Box E: What signal can developments in broad money provide for the economic outlook?).

But other factors could lead to greater second-round effects. High inflation over the past five years may have made inflation expectations more sensitive to inflation than in the past. Household inflation expectations could also rise by more as inflation is likely to be driven by the prices of highly visible items, such as energy and food. There could also have been changes to the way that companies adjust wages and prices in response to higher inflation, adding to inflationary pressures.

So far, there are few signs of second-round effects (Box B: Evidence on second-round inflation effects from the recent energy price rise). But there is not enough evidence yet to rule out this risk, and the MPC will continue to monitor evidence closely (Box A: A framework for monitoring second-round effects of higher energy prices).

Aside from energy prices, other global developments could add to inflationary pressures (Box D: What do global developments imply for the UK inflation outlook?). For example, rapid expansion of AI capacity is boosting the price of essential inputs, such as microchips, adding to companies’ cost pressures. And disruption to food supplies as a result of extreme weather events, for example a particularly strong El Niño, could lead to higher food price inflation.

Overall, the MPC judges at this time that second-round effects will probably be moderate. But the outlook is uncertain and the risk of strong inflationary pressures continues to be greater than the risk of weak inflationary pressures.

Key policy judgement 2

Monetary policy is weighing on inflation. The MPC is continuing to set policy to balance the costs of leaning too little against potential inflationary pressures and the costs of responding too much. The amount policy needs to lean, and the level of Bank Rate to achieve that, could change depending on how the outlook evolves.

Because the outlook is uncertain, the MPC needs to consider a range of possible outcomes and balance the costs of leaning too little against potential inflationary pressures and the costs of responding too much.

To inform its policy deliberations, the MPC has considered a central projection that is judged to provide a reasonable baseline alongside two scenarios that help to show how the outlook for UK inflation might differ given uncertainty about the path of global energy prices and strength of second-round effects (Section 3). These projections, which were conditioned on the path implied by market interest rates in the 15 working days to 20 July, are neither all-encompassing nor do they reflect the full distribution of risks. But they reflect key considerations in the MPC’s policy discussions.

The model-based policy simulations in Section 3.3 of the Report help the MPC to consider what is the right amount to lean against potential inflationary pressures given the MPC’s judgement that the risk of strong inflationary pressures in coming years is greater than the risk of weak inflationary pressures (Key policy judgement 1), by showing how well different monetary policy responses might perform in returning inflation to the 2% target if it were known for sure how the outlook would evolve.

The market curve underlying the projections captures both expectations about the future path of Bank Rate and risk premia (Box F: Developments in UK financial conditions). The interest rates faced by households and businesses are affected by the overall level of market rates, not by what has driven the move. So the illustrative policy paths in Section 3.3 should be interpreted as exploring alternative overall policy stances, rather than being read as alternative paths for Bank Rate.

• For the central projection, the illustrative policy rules are similar to the market curve over the coming year but lower after that.
• For the milder scenario, the illustrative policy rules are also similar to the market curve over the coming year and lower after that, and are somewhat lower than for the central projection.
• And for the adverse scenario, the illustrative policy rules are higher than the market curve.

At this meeting, the MPC decided it was appropriate to hold Bank Rate at 3.75%. Monetary policy is weighing on inflation, particularly once broader financial conditions are taken into account, and helping to insure against the risk of stronger inflationary pressures.

Where Bank Rate goes from here will depend on how the evidence, inflation outlook and risks around the outlook evolve, including the extent to which higher energy prices seem likely to generate strong inflationary pressures as they feed through the economy. However events unfold, the Committee stands ready to act as necessary to ensure that CPI inflation returns to the 2% target and stays there.

1: Current economic conditions

1.1: Inflation

CPI inflation was 2.6% in June; further progress on underlying disinflation has been offset by higher motor fuel prices.

The underlying disinflation process continued in 2026 Q2. That was evident in the June CPI release which, at 2.6%, was 0.4 percentage points lower than expected in the April Report (Chart 1.1). That reflected greater than expected disinflation across a wide range of goods and services, although food prices provided the largest downside news.

The underlying disinflation process has been offset by higher energy prices following the conflict in the Middle East. Motor fuel prices contributed 0.6 percentage points to CPI inflation in June (Chart 1.2, green bars).

Despite the boost from higher motor fuel prices, CPI inflation fell by 0.7 percentage points between March and June. In addition to further disinflation across CPI components, some of that fall reflected base effects, as sharp increases in prices of certain regulated items last year dropped out of the annual comparison from April, as well as the reduction in the Ofgem price cap in 2026 Q2 (Chart 1.2, orange bars).

Chart 1.1: The near-term outlook for CPI inflation has shifted in recent months

CPI inflation and near-term projections ^(a)

• Sources: ONS and Bank calculations.
• (a) The solid aqua line shows CPI data to June 2026, and the dashed aqua line shows Bank staff projections from July to December 2026. The dashed orange and purple lines show the near-term projections at the time of the April 2026 and February 2026 Reports, respectively.

Chart 1.2: CPI inflation was 2.6% in June but is projected to pick up to 3.2% in 2026 Q4

Contributions to CPI inflation ^(a)

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero (DESNZ), ONS and Bank calculations.
• (a) Figures in parentheses are CPI basket weights in 2026, which may not sum to 100% due to rounding. Data are shown to June 2026. Component-level Bank staff projections are shown from July to December 2026. The food component is defined as food and non-alcoholic beverages. The fuels and lubricants estimates use weekly DESNZ petrol and diesel price data which cover the first half of July 2026 and are then projected based on the sterling oil futures curve. The electricity and gas bars also include liquid fuels.

The underlying disinflation process continued in 2026 Q2.

Services price inflation fell from 4.5% in March to 3.6% in June (Chart 1.3, gold line), partly reflecting sharp rises in regulated prices in April of last year dropping out of the annual comparison. But annual underlying services price inflation measures also fell to around 3½% to 4% in June (aqua, orange and purple lines). Although still somewhat above Bank staff estimates of their target-consistent levels, the falls in those measures point to a broader slowing in domestic inflationary pressures and are also consistent with spare capacity in the economy helping to reduce inflation.

Chart 1.3: Measures of underlying services price inflation eased further in 2026 Q2

Measures of annual services price inflation ^(a)

• Sources: ONS and Bank calculations.
• (a) The low-variance measure is calculated by weighting each component of services inflation by the inverse variance of the change in 12-month inflation of that component from 12 months previously. The maximum adjusted weight is capped at twice its original value. Details of the components that have been included/excluded from the services excluding indexed and volatile components, rents and foreign holidays measure are included in the accompanying spreadsheet published online. The trimmed-mean measure excludes the 10% largest and 10% smallest price changes. The latest data points are for June 2026.

The further easing in domestic inflationary pressures has been supported by a continued slowing in wage growth. Private sector regular AWE growth eased to 2.9% in the three months to May (Chart 1.4, solid gold line). Although compositional shifts towards lower-paid industries continue to weigh on AWE growth by around 0.5 percentage points (shown by the difference between dashed and solid gold lines), momentum in private sector AWE growth has been subdued on a three-month on three-month annualised basis. Measures of pay growth from the DMP survey and the Indeed Wage Tracker remain higher, at around 4%, but have fallen gradually over recent months.

Whole economy total AWE growth has exceeded private sector regular pay growth. That difference largely reflects bonus payments, which do not tend to be a persistent driver of pay growth. Bonuses also appear to explain most of the gap between private sector regular AWE growth excluding compositional effects and the HMRC RTI measure (Chart 1.4, aqua line). Public sector regular pay growth has also been strong, partly reflecting the earlier implementation of this year’s NHS pay deal.

Annual private sector AWE growth is projected to average 2.8% in 2026 Q2 and around 3.0% in Q3 (Chart 1.4, gold diamonds), consistent with slack in the labour market continuing to weigh on wage growth (Section 1.2).

Chart 1.4: Private sector wage growth has continued to slow

Measures of private sector wage growth ^(a)

• Sources: DMP survey, HMRC, Indeed, ONS and Bank calculations.
• (a) The private sector regular pay growth line shows the ONS measure of private sector regular AWE growth, measured as the three-month average on the same period a year earlier. The DMP line shows average realised pay growth from the DMP survey on the same basis, while the HMRC RTI line shows a proxy of growth in median pay in the private sector, also measured as the three-month average on the same period a year earlier. Bank staff construct the HMRC RTI measure by taking median pay for each industry – excluding public administration and defence, education, health and social work – and weighting them by industry shares in payrolled employment. Annual growth is then calculated using the Laspeyres formula, holding industry weights fixed at their levels a year earlier to reduce the effect of changes in workforce composition. The Indeed Wage Tracker line shows annual average job title matched pay growth for UK job vacancies. The latest data points are for the three months to May 2026 for private sector regular pay, June 2026 for the HMRC RTI private sector median and the Indeed Wage Tracker, and July 2026 for the DMP survey. The private sector regular pay growth projection diamonds are for the three months to June and September 2026.

The Bank’s Agents continue to report average pay settlements of 3.5% for 2026, below the average settlement of 4.0% in 2025. Contacts cite a lower NLW increase this year, lower inflation at the time of settling and a looser labour market as driving that fall. Most 2026 settlements were agreed before the Middle East conflict, and not many contacts expect to review pay again this year. Some contacts report that knock-on effects from the conflict could slow wage disinflation in 2027. In the three months to July, however, respondents to the DMP survey expected average wage growth of 3.4% one year ahead, below reported realised wage growth of 4% over the past year (Box B).

While the underlying disinflation process appears to have continued, energy prices have pushed up inflation following the onset of the Middle East conflict.

CPI inflation is higher than expected in the February Report, when inflation had been projected to fall back to around 2% from April 2026 (Chart 1.1, dashed purple line). That difference mainly reflects the sharp rise in motor fuel prices, as well as higher fixed energy tariff and other liquid fuel prices. Overall, direct energy effects added 0.8 percentage points to CPI inflation on average in 2026 Q2, relative to the February Report projection (Chart 1.5, aqua bars). That was partly offset by greater than expected disinflation in other components (purple bars).

Chart 1.5: The indirect effects of the energy shock are projected to grow over the remainder of 2026

CPI inflation relative to the projection in the February Report ^(a)

• Sources: ONS and Bank calculations.
• (a) The bars show contributions to CPI inflation relative to the projection in the February Report. The bars to June 2026 are based on CPI outturns. The bars from July to December 2026 are based on Bank staff projections. As Bank staff’s February 2026 short-term inflation projection covered only six months, the expected direct energy contribution for 2026 H2 at the time of the February Report has been estimated using wholesale energy prices averaged over the 15 UK working days to 26 January 2026, together with the expected impact of the reduction in costs levied on household electricity and gas from April 2026 announced in Budget 2025 (Box D of the February 2026 Monetary Policy Report). The orange bars capture both domestic and imported indirect effects.

Energy prices have continued to be volatile but, as of the 15 days to 20 July, the direct contribution of energy to CPI inflation is expected to be slightly smaller than in the April Report.

Wholesale energy futures prices have been highly volatile since the April Report. In the 15 UK working days to 20 July, the front-month Brent crude oil futures price averaged $78 per barrel, below the $100 average ahead of the April Report but above the $64 average in the run-up to the February Report (Chart 1.6, left panel). Over the forecast period, the wholesale gas futures curve was, on average, 1% higher than ahead of the April Report and 33% above its level in the run-up to the February Report (right panel). Energy prices rose following the re-escalation of the Middle East conflict and have continued to be volatile in recent weeks.

Industry intelligence suggests that crude oil and gas flows through the Strait of Hormuz remain well below normal, with disruptions continuing to affect countries unevenly. The re-escalation of the conflict has led to further disruption to shipping flows and could also result in additional damage to Middle Eastern energy infrastructure.

Chart 1.6: Wholesale energy futures prices remain elevated relative to their levels prior to the conflict, but were a little lower for oil in the run-up to the July Report relative to three months earlier

Wholesale Brent crude oil and UK natural gas prices ^(a)

• Sources: Bloomberg Finance L.P., LSEG Workspace and Bank calculations.
• (a) Oil prices are Brent crude in dollars per barrel and gas prices are Bloomberg UK NBP Natural Gas Forward prices. In the left panel, the solid aqua line shows historical oil prices and the dashed aqua, orange and purple lines show futures curves based on forward prices averaged over the 15 UK working days to 20 July 2026, 22 April 2026 and 26 January 2026, respectively. In the right panel, the solid aqua line shows the historical evolution of the 12-month ahead natural gas futures price. The dashed aqua, orange and purple lines show 12-month ahead average gas futures curves, averaged over the same 15-day periods as the oil curves. The final data points for the July 2026 oil and gas futures curves are September 2029 and September 2028, respectively. The September 2028 gas futures data point is calculated as the average futures price between October 2028 and September 2029.

Crack spreads – the difference between the prices of refined petroleum products and Brent crude oil – have fallen from recent peaks for jet fuel and diesel but have continued to rise for petrol (Chart 1.7). Crack spreads remain well above their pre-conflict levels, and refined product markets remain tight, reflecting continued outages at Middle Eastern refineries, restrictions on Chinese oil product exports, reduced Russian oil product exports following intensified Ukrainian strikes on oil facilities, rapid inventory drawdowns and limited spare refining capacity outside Asia.

Chart 1.7: Crack spreads have eased from their peaks for some products but remain elevated

Jet fuel, diesel and petrol crack spreads ^(a)

• Sources: LSEG Workspace and Bank calculations.
• (a) The aqua bars show the spread between spot Northwest Europe (NWE) jet fuel prices and front-month Brent crude oil futures prices, using a conversion of 7.88 barrels of jet fuel per tonne. The orange and purple bars show the corresponding crack spreads for spot ultra-low sulphur NWE diesel and regular unleaded petrol, using conversion factors of 7.45 barrels and 8.33 barrels per tonne, respectively. The February, April and July 2026 bars are averages over the 15 UK working days to 26 January 2026, 22 April 2026 and 20 July 2026, respectively.

The direct contribution of higher energy prices to CPI inflation is expected to be around 0.4 percentage points in 2026 H2, a little lower than in the April Report but 0.7 percentage points greater than in the February Report (Chart 1.5, aqua bars). Within that, petrol and diesel pump prices are projected to contribute around 0.3 percentage points to CPI inflation on average, lower than in Q2 (Chart 1.2, green bars).

By contrast, higher wholesale gas futures prices will feed through more fully to household utility bills from July, following the increase in the Ofgem price cap to £1,663 in Q3 from £1,477 in Q2 (figures based on the new typical domestic electricity and gas consumption values that apply from Q3). The temporary removal of VAT on household electricity bills from October is expected to limit the rise in the Ofgem price cap in 2026 Q4 to around £1,680, around £45 lower than would have been the case without that measure. Overall, household utility bills are projected to contribute around 0.1 percentage point to CPI inflation on average over H2 (Chart 1.2, orange bars).

The indirect effects of the energy shock are expected to grow over the remainder of this year, but by a little less than projected in the April Report.

Indirect effects arise as firms at home and abroad pass higher energy costs through supply chains to consumer goods and services prices (Boxes A and D). That pass-through typically occurs more slowly than for the direct effects of an energy price shock (Box A of the April 2026 Monetary Policy Report) and recent CPI data are consistent with modest effects so far (Chart 1.5, orange bars). Indirect effects are projected to build over 2026 H2 and to contribute around 0.5 percentage points to CPI inflation in December, based on intelligence from the Bank’s Agents alongside data news and model and survey-based evidence. That combination of evidence is consistent with indirect effects building more slowly than projected in the April Report.

Energy costs are an important component of food production and distribution costs. Models that incorporate energy costs in domestic and imported supply chains, alongside survey evidence and intelligence from the Bank’s Agents, suggest pass-through of higher energy costs will be slightly faster for food than for other CPI components. Food price inflation is projected to rise to nearly 3.5% in December 2026 (Chart 1.8, solid orange line). That is less than expected in the April Report, largely reflecting downside news in food prices over recent months – some of which is judged to reflect easing agricultural commodity price pressures – as well as developments in wholesale energy markets.

The lower projection for food price inflation than at the time of the April Report is directionally consistent with recent intelligence from the Bank’s Agents. Contacts of the Agents report that they now expect food price inflation to reach around 4%–5% by the end of the year (Agents’ summary of business conditions – July 2026 (ASBC)). Supermarkets report fragile consumer demand and intense competition. As such, they are focused on cost management and are resisting proposals for price increases from suppliers.

The indirect pass-through of higher energy costs is also expected to raise core goods inflation. Intelligence from the Bank’s Agents suggests that, while production of many core goods – such as clothing, footwear and household goods – is less directly affected than food by the energy shock, some producers are facing higher transport costs.

Overall, core goods inflation is expected to rise by 0.7 percentage points to around 1.4% in December (Chart 1.8, solid purple line). Alongside the indirect impact of energy costs, that projection incorporates an expectation that building price pressures for memory chips will raise costs for a broad range of goods over 2026 H2 (Box D).

Services inflation is also expected to increase slightly over coming months, reaching 3.8% in October (Chart 1.8, solid aqua line). Higher energy and food prices are expected to increase non-labour input costs for many firms in the sector, such as airlines and catering services. Underlying services measures are expected to remain broadly stable, however, as further progress in underlying disinflation offsets the indirect effects of the energy price shock.

Chart 1.8: Inflation rates are projected to pick up across CPI components, most notably for food

Annual inflation rates for components of CPI ^(a)

• Sources: ONS and Bank calculations.
• (a) The core goods component is defined as goods excluding food and non-alcoholic beverages (FNAB), alcohol, tobacco and energy. The data are to June 2026, with Bank staff projections from July to December 2026. The dashed lines represent the 2012–19 averages, which are 2.7%, 0.9% and 0.5% for services, FNAB and core goods, respectively.

CPI inflation is expected to average 3.2% in 2026 Q4.

The near-term CPI inflation projection rises to 3.2% in October and November 2026 before easing a little (Chart 1.2, white line). Direct effects of higher energy prices are projected to rise over coming months before fading somewhat in 2026 Q4. As a result, the expected pickup in CPI inflation by the end of this year is primarily accounted for by indirect effects (Chart 1.5, orange bars). Within that, higher food and other goods price inflation are expected to drive much of the increase in inflation. Building price pressures for memory chips are also expected to contribute to the rise in core goods inflation and to some of the remaining difference between the current CPI inflation projection and that at the time of the February Report (purple bars).

Inflation expectations

Inflation expectations remain elevated, especially at shorter horizons.

There is a risk that the energy price shock generates more persistent inflation through second-round effects if higher inflation expectations feed through to wage-setting or pricing decisions. While there is little evidence so far to suggest large second-round effects, some of the most important evidence will only appear with a lag (Box B).

Short-term inflation compensation measures in financial markets remain above pre-conflict levels (Chart 1.9, orange line in left panel) and have been more sensitive than usual to developments in energy markets over this period. By contrast, medium-term measures, such as the five-year, five-year forward inflation swap rate, have been much less volatile and rose by significantly less in response to the Middle East conflict (aqua line in left panel).

The Market Participants Survey (MaPS) may provide a cleaner read of market participants’ inflation expectations, since market-based measures of inflation compensation are also affected by liquidity and risk premia as well as technical factors related to the demand and supply of inflation protection. In the latest MaPS, the median respondent expected CPI inflation to be 2.5% one year ahead, a little below the 2.8% expected in the April Report, and for inflation to return to the 2% target at the three-year horizon.

Near-term business inflation expectations eased in July but remain slightly above their pre-conflict levels. One-year ahead CPI expectations among firms responding to the DMP survey stood at 3.4% in the three months to July, 0.3 percentage points above their level in the three months to February (Chart 1.9, orange line in middle panel). One-year own-price expectations rose by 0.4 percentage points over this period, to 3.9%. By contrast, three-year ahead CPI inflation expectations have been relatively stable (aqua line in middle panel).

Household inflation expectations remain elevated but have also fallen from recent peaks (Chart 1.9, right panel). They tend to move closely with observed changes in salient prices such as food and energy (Box C in the April 2026 Monetary Policy Report). The Citi/YouGov one-year ahead measure fell to 3.4% in July, probably reflecting lower motor fuel prices than in April. The Citi/YouGov 5–10 year ahead measure also eased in the latest data to 3.7%, 50 basis points above its historical average and around 10 basis points higher than its pre-conflict level.

Chart 1.9: Inflation expectations remain elevated, especially at shorter horizons

Market-based measures of inflation compensation ^(a) and survey-based measures of business ^(b) and household inflation expectations ^(c)

• Sources: Bloomberg Finance L.P., Citigroup, DMP survey, YouGov and Bank calculations.
• (a) The data show cumulative changes in market-based measures of inflation compensation since 31 December 2025. The orange line shows the one-year inflation swap rate, and the aqua line shows the five-year, five-year forward inflation swap rate. A short back-run is shown because of the impact of RPI reform, which distorted the five-year, five-year forward inflation swap rate between April 2020 and March 2025. From 2030, UK RPI will be aligned with the CPIH measure of consumer prices. The final data points are for 20 July 2026.
• (b) The data are from the DMP survey and show three-month averages. The data are in response to the question: ‘What do you think the annual CPI inflation rate will be in the UK, one year from now and three years from now?’. The latest data points are for July 2026, with the survey conducted between 3–17 July. The DMP survey data have a short back-run, so no historical averages are shown.
• (c) The data are from the Citi/YouGov survey and are based on responses to the questions: ‘How do you expect consumer prices of goods and services will develop in the next 12 months?’, and ‘And what do you think will happen to the prices of goods and services, on average, over the longer term – say five to ten years?’. The dashed lines represent the series averages over 2010–19. The latest data points are for June 2026, with the survey conducted between 22–23 June. The chart does not show the July 2026 Citi/YouGov data, which was released after the data cut-off for incorporation in the charts.

1.2: Activity

Domestic demand

Underlying GDP growth is projected to weaken slightly in coming quarters, as subdued momentum persists and the effects of the Middle East conflict weigh somewhat on demand.

Underlying GDP is estimated to have grown by 0.1% in 2026 Q2 (Chart 1.10, orange line) based on the collective steer from business survey indicators. That is below Bank staff’s estimate of potential supply growth of around 0.3%–0.4%, consistent with a widening margin of slack. Headline GDP growth is expected to have been higher than underlying growth, at 0.3% in 2026 Q2 (aqua line), although that reflects some remaining strength from Q1 when GDP grew by 0.6%.

Subdued underlying GDP growth partly reflects a continuation of weak momentum prior to the Middle East conflict, consistent with subdued household and business confidence. But the conflict is also judged to have begun to weigh on demand through lower household real income growth, greater uncertainty and tighter financial conditions. Forward-looking survey indicators have generally been soft, consistent with these channels having started to play out, although the flash July S&P Global UK PMI Survey data signalled an improvement in business conditions and there is little evidence so far that the conflict has triggered a sharp contraction in activity.

Business survey data suggest that growth in the services sector has been subdued. The S&P Global UK PMI Survey services output index fell after the onset of the conflict and remained slightly below its historical average in July, with respondents citing elevated risk aversion and continued weakness in consumer spending. Manufacturing growth has been stronger, although survey indicators suggest some of that resilience may reflect front-loading of purchases ahead of anticipated price rises and supply chain disruption. The S&P Global UK PMI Survey manufacturing stocks of purchases index rose to its highest level since mid-2022 in May before falling back sharply in the latest data. Contacts of the Bank’s Agents in the manufacturing sector generally report weak trading conditions.

Underlying GDP growth is projected to slow to around 0% in 2026 Q3 (Chart 1.10, orange line), as the effects of the conflict weigh further on demand. The S&P Global UK PMI Survey composite future output index ticked up in the July flash release although it remains below its historical average, pointing to continued weak momentum in activity. Weak underlying demand conditions should reduce the likelihood of second-round effects in price and wage-setting from the energy price shock (Box B).

Chart 1.10: Underlying GDP growth is projected to weaken slightly in the near term

Quarterly growth in headline GDP and underlying growth implied by business surveys ^(a)

• Sources: Bank of England Agents, BCC, CBI, Lloyds Business Barometer, ONS, S&P Global and Bank calculations.
• (a) The final data point for quarterly headline GDP growth is for 2026 Q1. The diamonds for 2026 Q2 and Q3 show Bank staff projections. Underlying GDP growth estimates are from a survey indicator model, based on a staggered-combination mixed-data sampling (MIDAS) approach (Moreira (2025)). The orange diamonds to 2026 Q1 show in-sample fitted values of the survey indicator model, and diamonds for Q2 and Q3 show out-of-sample projections. The orange swathe shows the interquartile range of estimates from individual survey indicators in the model, and values have been interpolated between quarters.

Business investment is expected to soften over coming quarters, as lower confidence and higher borrowing costs weigh on investment intentions.

Business investment grew by 0.9% in 2026 Q1 but is expected to soften over coming quarters. Measures of business confidence have fallen since the Middle East conflict, although by somewhat less than after the 2022 energy price shock. Weaker confidence is likely to weigh on firms’ investment intentions. Contacts of the Bank’s Agents report that investment intentions have fallen since the start of the conflict owing to higher uncertainty and financing costs and are broadly flat for the year ahead.

Household spending is expected to moderate in response to the energy price shock, but not to contract sharply.

Consumption grew by 0.6% in 2026 Q1, stronger than in recent quarters, despite a 0.2% fall in real incomes. As a result, the household saving rate fell by 0.7 percentage points to 8.9%, although it remains above its pre-pandemic average. Early estimates of these data are volatile and can be subject to large revisions.

Consumption growth is expected to have eased to 0.3% in 2026 Q2, in line with slower GDP growth. It is expected to weaken further over coming quarters, as higher inflation and subdued wage growth weigh on real income growth. Recent rises in mortgage rates are also expected to weigh on consumption growth (Box F).

Households may smooth through some of the impact of the energy price shock by reducing their spending by less than the fall in their real incomes (Box E of the April 2026 Monetary Policy Report). That may involve households reducing the pace at which they are currently saving, drawing down on existing savings or increasing borrowing. Consistent with that, a forward-looking gauge of households’ willingness to save from the ONS Public Opinions Survey, which has broadly tracked the household saving rate in recent years, has fallen since the start of the conflict. Weaker flows into household deposits over recent months also point to further declines in the saving rate. Meanwhile, timelier spending indicators, including ONS retail sales growth, have remained relatively resilient since the start of the conflict, suggesting that households may already have begun to smooth through part of the squeeze in their real incomes.

Overall, consumption is projected to grow by 0.1% in 2026 Q3 and to remain subdued over coming quarters, but not to contract sharply. Consistent with that, consumer confidence measures, which provide a forward-looking signal for consumption, have fallen a little, but by much less than after the pandemic or Russia’s invasion of Ukraine (Chart 1.11).

Chart 1.11: Consumer confidence indicators have weakened but by less than in 2022

Measures of consumer confidence ^(a)

• Sources: GfK, S&P Global, YouGov and Bank calculations.
• (a) The YouGov Consumer Confidence Index (CCI) asks respondents about household finances, job security, house prices and business activity over the past month and the year ahead. The S&P Global Consumer Sentiment Index (CSI) covers current finances and expectations for the year ahead, sentiment around debt, savings and the labour market, and views on major purchases and cash available to spend. The GfK CCI asks about personal finances and general economic conditions over the past year and the year ahead, as well as attitudes towards major purchases. All series are standardised using data since 2009 and are shown as three-month averages. The latest data are for June 2026 for the YouGov and GfK CCIs, and July 2026 for the S&P Global CSI. The chart does not show the July 2026 GfK CCI data, which was released after the data cut-off for incorporation in the charts.

Labour market

The labour market continues to operate with a degree of spare capacity.

Bank staff judge that underlying employment growth has been broadly flat since early 2025, based on the signal from a range of measures, with little evidence of a marked change following the onset of the Middle East conflict. HMRC RTI data, which give a timely read on employment, point to a small fall in payrolled employees over recent months, while the S&P Global UK PMI employment index remained below its historical average in July. Contacts of the Bank’s Agents report that the conflict has led to greater caution in employment intentions and some delays in hiring, and around a quarter of respondents to the July 2026 DMP survey expected employment to be lower because of the conflict.

Intelligence from the Bank’s Agents suggests AI adoption is gradually reducing demand for highly automatable jobs in some industries, with firms often slowing hiring or leaving vacancies unfilled to increase output without a proportional rise in headcount. Consistent with that, respondents to the latest DMP survey expected AI to reduce employment by around 0.4% per year and to boost productivity by around 0.9% per year over the next three years. The effects of AI remain highly uncertain, however. Nearly 90% of DMP survey respondents report no material impact of AI on their employment over the past three years, and the creation of new businesses and jobs may offset some future employment impacts.

The LFS unemployment rate stood at 4.9% in the three months to May (Chart 1.12), 0.2 percentage points lower than projected in the April Report. The headline unemployment rate has been volatile in recent months, reflecting both changes in inactivity and employment.

The unemployment rate is expected to rise a little over coming months. Bank staff project the unemployment rate to rise gradually to 5.0% in 2026 Q3 and 5.1% in Q4 (Chart 1.12). That rise is expected to mainly reflect continued weakness in hiring rather than an increase in job losses, consistent with subdued indicators of employment intentions and recent falls in the ONS redundancy rate. Forward-looking HR1 notifications of potential redundancies among larger firms have risen over recent months, however, which could point to the risk of a slightly sharper increase in unemployment over coming quarters.

Chart 1.12: The unemployment rate is projected to rise a little over 2026 H2

LFS unemployment rate and near-term projections ^(a)

• Sources: ONS and Bank calculations.
• (a) The aqua diamonds show projections for the LFS unemployment rate from 2026 Q2 to Q4, based on official data to May 2026 (shown in the aqua line). Although LFS unemployment data have been reinstated by the ONS, they are badged as official statistics in development and the LFS continues to suffer from low response rates, which can introduce volatility and potentially non-response bias (Box D of the May 2024 Monetary Policy Report). An ONS operational error temporarily reduced LFS response rates during May and June 2026, leading to increased use of imputation for this period. ONS analysis to date indicates that the error has had minimal impact on headline employment, unemployment and inactivity rates, although it may have had a slightly larger impact on the estimates of average and total actual hours worked.

Broader indicators continue to point to a margin of slack in the labour market. The vacancies to unemployment ratio (V/U) remains below its estimated equilibrium (Chart 1.13, left panel) and net additional hours desired by workers as a share of average hours worked continue to indicate some degree of underemployment (middle panel). Meanwhile, the marginal attachment rate points to a growing share of people not currently looking for work but who would like a job (right panel), which could indicate some further loosening in the labour market since the April Report. That would be consistent with intelligence from the Bank’s Agents, which suggests that recruitment difficulties have eased to a little below normal (ASBC – July 2026).

There is a high degree of uncertainty over the precise level of slack in the labour market. Bank staff judge that most of the increase in the unemployment rate since mid-2022 has reflected weaker demand, but some structural factors may also have contributed. Higher labour costs reflecting increases in the NLW and employer NICs, for example, may have reduced demand for lower-paid workers in sectors with a high share of jobs near the NLW, such as hospitality.

Chart 1.13: The labour market continues to operate with a degree of spare capacity

Indicators of labour market slack ^(a)

• Sources: Advertising association/World Advertising Research Centre Expenditure Report, ONS and Bank calculations.
• (a) The equilibrium V/U ratio in the left panel is estimated using an error-correction model over the period 1982–2025. The real cost of vacancy posting and hourly labour productivity are included as long-run determinants for the level of vacancies. The model also includes controls for short-term movements in these variables (Stelmach et al (2025)). The latest data are for 2026 Q1. The 2026 Q2 data points are projections based on data to the three months to May. The middle panel shows the number of net additional hours that the currently employed report they would like to work, on average, per week, expressed as a share of average weekly hours. The latest data are to 2026 Q1 and the vertical axis is inverted. The data in the right panel are three-month averages of the share of people aged 16–64 who report that they are not in work or not actively looking for work but would like a job. The latest data are for the three months to April 2026 and the vertical axis is inverted.

Spare capacity in the economy should reduce the risk of additional second-round effects in price and wage-setting.

The overall margin of spare capacity in the economy is judged to have widened a little further since the April Report. Contacts of the Bank’s Agents continue to report modest spare capacity, partly reflecting weak demand. And most model-based estimates of the output gap point to slack having increased slightly, to around 1% of potential GDP. Spare capacity in the economy should reduce the risk of additional second-round effects on inflation by weakening workers’ wage bargaining and firms’ pricing power (Box B and Section 3).

1.3: Global and financial conditions

Global economic activity

Global growth has slowed over 2026.

The conflict in the Middle East represents a negative supply shock to the global economy. Since the April Report, the Memorandum of Understanding (MoU) between the US and Iran had facilitated the reopening of the Strait of Hormuz and a partial recovery in shipping and energy flows, contributing to a decline in wholesale oil and gas prices. But renewed attacks on shipping and a broader re-escalation of the conflict following the MoU constrained the recovery of oil flows and energy prices have been volatile in recent weeks. Disruption and damage to regional energy infrastructure are expected to constrain energy supply in coming quarters.

The effects of the conflict are judged to be weighing on global demand, but by less than expected at the time of the April Report given the fall in energy prices in the run-up to the July Report (Section 1.1). The effects of the conflict are being partly offset by strong AI-related investment, particularly in the US where it is estimated to have accounted for a substantial share of recent private investment growth (Chart 1.14, aqua bars). In the year to 2026 Q1, US investment in these AI-related components grew by 18%, compared with a four-quarter average growth rate of just over 7% during the period 2010–19. Based on Bank staff estimates that account for the import content of AI-related goods, this investment accounted for as much as a fifth of overall US GDP growth in the year to 2026 Q1. Such investment is also supporting AI-related export demand in developed Asian economies (Box D).

The average global effective tariff rate on US imports remains lower than it was in 2025, although tariffs are judged to still be weighing somewhat on global demand. On 24 July the US imposed new tariffs of 10%–12.5% on a broad range of countries, replacing the previous 10% tariffs which had been time-limited. The bilateral US-UK tariff rate is unchanged and the overall effects are expected to be small for the UK.

Chart 1.14: US investment growth has been driven by AI-related spending in recent quarters

Contributions to quarterly growth in US private fixed investment ^(a)

• Sources: BEA, LSEG Workspace and Bank calculations.
• (a) AI-related investment is defined broadly to include computers and peripheral equipment, communications equipment, special industry machinery, power infrastructure, data centres, software and AI-related R&D. AI-related R&D is assumed to account for 25% of total R&D investment, based on the share of BEA R&D categories judged to be most closely related to AI.

Four-quarter UK-weighted world GDP growth was 2.1% in 2026 Q1 and is expected to have slowed in Q2 (Chart 1.15). The June JP Morgan Global Composite PMI and new orders balances were a little above their recent troughs but lower than prior to the conflict, while the future output and employment balances were below their historical averages. Global growth is expected to be broadly unchanged in Q3 as the negative effects of the earlier energy shock continue to pass through supply chains. Relative to last year, US growth is expected to be robust over 2026 while euro-area growth is expected to be relatively weak, reflecting the effects of the Middle East conflict.

Chart 1.15: World GDP growth has decelerated in 2026

Four-quarter UK-weighted global GDP growth with contributions by region ^(a)

• Sources: LSEG Workspace and Bank calculations.
• (a) The figures for 2026 Q2 and 2026 Q3 are Bank staff projections. UK-weighted world GDP growth is constructed using real GDP growth rates of 188 countries weighted according to their shares in UK exports.

Financial conditions

The UK forward OIS curve is a little higher compared with the April Report.

Based on the 15-day average of forward interest rates to 20 July, the UK market curve was five basis points higher on average over the next three years compared with the path at the time of the April Report (Chart 1.16). The market curve rises to around 4.2% by the latter half of 2027 and remains broadly flat thereafter. The curve has risen further in recent weeks following the re-escalation of the Middle East conflict.

The euro-area forward OIS curve was broadly unchanged over the coming three years relative to in the run-up to the April Report, based on the 15-day average to 20 July, while the US curve was around 50 basis points higher on average from 2027 onwards. Market contacts have mainly attributed the upward shift in the US curve to expectations of a tighter policy stance following the June FOMC meeting.

Chart 1.16: The UK forward OIS curve is a little higher compared with the April Report

Policy rates and instantaneous forward curves for the UK, US and euro area ^(a)

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) The July 2026 curves are estimated based on the 15 UK working days to 20 July 2026. The April 2026 curves are estimated based on the 15 UK working days to 22 April 2026. The federal funds rate is the upper bound of the announced target range. The market-implied path for US policy rates is the expected effective federal funds rate. The ECB deposit rate is based on the date from which changes in policy rates are effective. The final data points are forward rates for September 2029.

UK financial conditions have tightened since the April Report.

UK financial conditions are materially tighter than prior to the conflict in the Middle East, primarily due to higher short-term market interest rates (Box F). They have also tightened further since the April Report, reflecting a 1% appreciation of the sterling ERI and an increase in market rates at the two to three-year horizon (Chart 1.16). Longer-term UK government bond yields have also risen since April and are at around their highest level since 2008. The UK FTSE All-Share index is broadly unchanged while the S&P 500 and Euro Stoxx indices are around 10% and 6% higher, respectively. Market-based measures of uncertainty, such as the VIX and MOVE Index, which capture option-implied volatility in US equity prices and US Treasury yields, have fallen since the April Report and remain well below the peaks seen last year following US tariff announcements and below those observed in 2022.

Domestic credit conditions

Interest rates faced by households and firms have generally fallen a little in recent weeks but remain higher than prior to the conflict.

Mortgage rates and their reference rates remain higher than prior to the conflict in the Middle East (Box F). Reference rates are little changed from the time of the April Report. The rates on mortgage products that are priced based on these are currently around 40 basis points lower than in April (Chart 1.17), reflecting standard lags in pass-through. Reference rates have been volatile, however, and the most recent increases are starting to be passed through to quoted mortgage rates. Bank staff analysis finds that increases in reference rates tend to be passed through to mortgage rates more quickly than decreases when movements in reference rates are large or volatile.

The average quoted rate on two-year time deposits has risen by around 20 basis points since the April Report (Chart 1.17, gold line), although pass-through of changes in reference rates has been broadly in line with historical averages since February. Rates being charged on personal loans have risen by around 50 basis points since the April Report (Chart 1.17, aqua line). Changes in reference rates tend to pass through to rates charged on consumer credit with a lag.

Quoted rates on sight deposits have been little changed since the April Report, consistent with Bank Rate – the relevant reference rate – having been unchanged. Meanwhile rates on new bank lending to corporates have declined a little. Mortgage and corporate credit spreads remain compressed by historical standards.

Chart 1.17: Mortgage rates have fallen since the April Report while time deposit rates have risen a little

Household interest rates and their corresponding reference rate ^(a)

• Sources: Bank of England, Bloomberg Finance L.P. and Bank calculations.
• (a) Household loan and deposit rates are based on average quoted rates. The Bank’s quoted rates series are weighted monthly average rates advertised by all UK banks and building societies with products meeting the specific criteria. Introduction of new Quoted Rates data provides more information. The 75% and 90% LTV mortgage rates are for two-year fixed-rate products. The reference rate for these and fixed-rate savings bonds is the two-year OIS rate. The reference rate for £10,000 personal loan rates is the five-year OIS rate but this is not shown. The two-year OIS rate shows monthly averages. Household quoted rates data are not seasonally adjusted. The provisional July 2026 data are shown as diamonds. For quoted rate series and the two-year OIS rate, these are based on average values to 20 July 2026.

Respondents to the latest Credit Conditions Survey – 2026 Q2 reported that availability of secured credit to households and firms had been broadly stable on average since the onset of the Middle East conflict. Housing market activity has been weak, however, and mortgage approvals for house purchase fell by nearly 15% in May, the largest monthly decline since late-2022, and were broadly flat in June. This weakness probably reflects a combination of economic uncertainty and the bringing forward of some mortgage activity into earlier months in anticipation of higher mortgage rates. The RICS new buyer enquiries net balance remains very weak by historical standards, and lenders responding to the Credit Conditions Survey expected demand for secured lending for house purchases to fall in the months ahead. These developments are consistent with reports from the Bank’s Agents which point to affordability concerns and the rise in mortgage rates since the conflict weighing on housing market activity (ASBC – July 2026).

3: Outlook, scenarios and risks

There continues to be uncertainty around the impact on the UK economy from the shock to energy prices related to the Middle East conflict. This impact will depend on the scale, duration and propagation of the shock, including the extent to which it generates material second-round effects in price and wage-setting.

This section presents a central projection and two scenarios to help explore the outlook and key sources of continued uncertainty around the future paths of global energy prices and the strength of second-round effects. The central projection is a baseline that the majority of the MPC agree is reasonable, with energy prices conditioned on futures curves and moderate, persistent second-round effects from the latest energy shock. A ‘milder’ scenario for inflation assumes a lower energy price path, and weaker underlying demand resulting in no additional second-round effects from the energy shock. An ‘adverse’ scenario assumes higher energy prices for the entire period with significantly larger second-round effects. The scenarios help to illustrate that, relative to the central projection, the risk of strong inflationary pressures continues to be greater than the risk of weak inflationary pressures.

The MPC sets monetary policy taking into account the likelihood and impact of a range of outcomes, balancing the costs of leaning too little against the risk of stronger inflationary pressures against the costs from responding too much. For the central projection and the milder scenario, illustrative policy rules are similar to the market curve over the coming year but lower after that. For the adverse scenario, the illustrative policy rules are higher than the market curve.

3.1: Key assumptions and judgements in the central projection and scenarios

As was the case in the April Report, the outlook for UK inflation and activity is being shaped by two key uncertainties. The first is the outlook for global energy prices. Energy prices continue to be elevated and volatile. For example, since the start of the conflict, front-month Brent crude prices have fluctuated between lows of around $70 to well over $110 per barrel, and measures of oil price volatility have remained above historical norms. Moreover, the spread between the price of refined petroleum products and Brent crude oil, known as crack spreads, remains well above pre-conflict levels (Section 1.1).

The second uncertainty is the strength of any second-round effects in domestic price and wage-setting, which may be closely related to the magnitude and persistence of the global energy shock. A monitoring framework suggests that it will take time to learn about the strength of these effects (Box A), and the MPC will closely evaluate emerging evidence to ensure that inflation does not remain persistently above target.

This section sets out some projections for the economy to help explore the range of outcomes. The central projection is based on a staff proposal which the majority of the MPC agrees is a reasonable baseline. There are two scenarios, labelled as ‘milder’ and ‘adverse’, which explore impacts of plausible alternative assumptions for energy prices and second-round effects (Table 3.A).

These projections and scenarios are deemed to be particularly relevant to the MPC’s policy discussions, but they are neither all-encompassing nor do they reflect the full distribution of risks. For example, other global risks to UK inflation not directly related to the Middle East conflict, such as from AI and weather disruption (Box D), are not explored in these scenarios.

The central projection and scenarios are conditioned on the market curve for short-term interest rates in the 15 UK working days to 20 July. The market curve rose over this period, particularly following the breakdown of the MoU between the US and Iran, and subsequent rises in energy prices. Section 3.3 illustrates the impact on inflation of changing that interest rate conditioning assumption for the central projection and scenarios by drawing on some policy rules.

Other standard conditioning assumptions are set out in the Projections Databank accompanying this Report. The projections are conditioned on the Government’s fiscal plans as set out in Budget 2025, as well as recent additional fiscal announcements of a removal of VAT on household electricity bills from October 2026 for six months (Section 1.1) and a £2 bus fares cap over 2027.

Energy price assumptions

Chart 3.1 illustrates the conditioning paths for wholesale oil and gas prices in the central projection and both scenarios.

The central projection is conditioned on wholesale energy prices evolving in line with gas and oil futures curves in the 15 UK working days to 20 July. In this projection, oil prices gradually decline from $76 per barrel in 2026 Q3 to around $71 per barrel at the end of the forecast period. Gas futures prices peak at a little over 123 pence per therm in 2026 Q4 before declining to a little under 60 pence per therm at the end of the projection. The central projection for inflation additionally accounts for the currently elevated spreads of refined petroleum product prices over and above Brent crude oil (Section 1.1), and the outlook for them embedded in futures prices.

In the milder scenario, energy prices follow a slightly lower path than in the central projection. The assumed Brent crude oil futures curve is around 3% lower than in the central projection, while the gas futures curve is around 6% lower, on average. These paths were calibrated to the futures curves around the beginning of July. These prices are consistent with the period of lower energy prices after the MoU was signed, and so are judged to be a reasonable proxy for an external environment in which a ceasefire agreement is fully implemented, and energy price volatility is relatively lower.

In the adverse scenario, energy prices rise materially above the path implied in the central projection and remain above that path over the forecast period. The assumed Brent crude oil price is around 30% higher on average than in the central projection and the wholesale gas price is around 60% higher. Both oil and gas paths are assumed to remain well above the central projection throughout the forecast period. These paths are judged to be a reasonable proxy for a state of the world in which the conflict continues, perhaps in an episodic manner and with no clear resolution, which leads to a persistent energy shock over the entire forecast period. The path for energy prices is, nevertheless, less severe than in Scenario C published in the April Report.

Chart 3.1: Energy price paths are higher in the adverse scenario relative to the central projection and milder scenario

Brent crude oil ^(a) and natural gas ^(b) price paths in in the central projection, milder scenario and adverse scenario

• Sources: Bloomberg Finance L.P., LSEG Workspace and Bank calculations.
• (a) Historical spot prices are quarterly averages of Brent crude oil prices and are in US dollars. The dashed lines refer to the conditioning assumptions for the central projection, and the milder and adverse scenarios, as outlined in Table 3.A. The final data are for 2029 Q3.
• (b) Historical spot prices are quarterly averages of Bloomberg UK NBP Natural Gas Forward Day prices and are in sterling. The dashed lines refer to the conditioning assumptions for the central projection, and the milder and adverse scenarios, as outlined in Table 3.A. The final data are for 2029 Q3.

Assumptions around second-round effects on inflation

The central projection assumes moderate additional second-round effects from the recent energy shock. That is consistent with a margin of slack in the economy (Section 1.2), in part reflecting the loosening in the labour market since the energy shock in 2022. The calibration of the impact is informed using the model in Bernanke and Blanchard (2025), applied to the UK. Energy shocks affect inflation via expectations and wage-setting, although they could be consistent with some degree of firm pricing power (Haskel et al (2025)). In this Report, these effects have been calibrated using an augmented version of the model estimated on data that includes a period when attentiveness to inflation was elevated (Box B). This adapted calibration results in inflation expectations responding slightly more to inflation shocks than assumed in Scenario B of the April Report, and generates more persistence in second-round effects in the medium term.

The milder scenario assumes that there are no second-round effects in response to the current energy shock, because greater slack in the labour market and weakness in demand limits worker bargaining and firm pricing power. This scenario explores similar downside risks to activity as in Scenario A published in the April Report, but assumes that a greater degree of precautionary savings, rather than a reduction in real incomes due to the energy shock, leads to weaker demand (Box D of the November 2025 Monetary Policy Report).

In the adverse scenario, persistently elevated energy prices lead to inflation expectations drifting higher, leading to disproportionately stronger second-round effects than assumed in the central projection, generated using the same mechanism as underlying Scenario C published in the April Report. Similar inflation paths could also be generated by intrinsic persistence stemming from potential structural changes in price and wage-setting behaviour (Box B of the November 2025 Monetary Policy Report).

3.2: Central projection and scenario outcomes

Table 3.B sets out how key economic variables evolve across the central projection, milder and adverse scenarios, conditioned on the market curve for interest rates. The central projection and scenarios collectively explore a reasonable range of risks around energy prices and second-round effects discussed by the MPC. The choice of projections has been partly based on new Bank staff analysis (Brignone et al (2026)), which sets out one way to assess the calibration of the span of scenarios against a benchmark reference distribution. The fan charts around the central projection in Chart 3.2 continue to be based only on the distribution of historical forecast errors, and do not attempt to represent the skew of risks around the current outlook.

Overall, the scenarios span outcomes that are considerably higher than in the central projection as well as outcomes that are lower. Outcomes with higher inflation than the adverse scenario, such as Scenario C in the April Report, remain a possibility, though are judged to be less likely.

Chart 3.2: CPI inflation in the central projection is expected to return to the 2% target in 2027 and remain around that rate in the medium term. GDP growth and the unemployment rate is projected to rise modestly in the medium term

Annual CPI inflation , GDP growth and unemployment rate ^(a)

• Sources: ONS and Bank calculations.
• (a) The fan charts depict the probability of various outcomes for GDP growth, the International Labour Organization (ILO) definition of unemployment and CPI inflation in the central projection. The uncertainty parameters determining the width of the fan charts have been calibrated to match the historical forecast errors since 2004 and up to 2025 Q2 for each variable at different horizons but exclude errors during the pandemic given its exceptional nature. The fan charts are constructed so that outturns are expected to lie within each pair of lighter areas on 30 occasions, with outturns expected to lie within the fan on 90 out of 100 occasions. On the remaining 10 out of 100 occasions, outturns can fall outside the respective aqua, orange and purple areas of the fan chart, depicted by the blue background. For GDP growth, the distribution reflects uncertainty around past data revisions and future evolution, so that the mature estimate would lie within the darkest central band on only 30 out of 100 occasions. The Committee no longer uses the calibration of the fan chart skew to reflect judgements on the balance of risks to the central projection.

Inflation

Conditioned on the market curve, CPI inflation rises in the near term in the central projection, peaking at around 3.2% in 2026 Q4 (Chart 3.3, left panel). The increase in inflation in the near term is accounted for primarily by the direct effects of higher energy prices (Chart 3.4, aqua bars). The indirect effects of higher energy prices are also expected to push up on inflation in the near term (Section 1.1). The rise in inflation is supported by upward pressure from non-fuel import prices, which, in addition to the pass-through of the energy shock, are also stronger due to AI-related global export price pressures (Box D).

CPI inflation in the central projection ends the forecast at 1.9%. The projected decline in inflation from its near-term peak largely reflects a fading contribution from non-fuel import prices and energy-related base effects. CPI inflation excluding direct energy contributions is higher than CPI inflation for much of the second half of the forecast. Second-round effects push up on CPI inflation by around 0.2 percentage points at their peak over 2028, before fading slightly by the end of the forecast period (Chart 3.3, right panel). Private sector regular wage growth is projected to remain stable at a little above 3% over the forecast period. A degree of slack weighs on inflation and wage growth over the forecast period.

In the milder scenario, the near-term peak in CPI inflation is slightly lower than in the central projection at 3% in 2026 Q4, reflecting smaller contributions from direct energy effects (Chart 3.4, purple bars). CPI inflation and inflation excluding energy are projected to be somewhat lower than in the central projection over the forecast period, mainly reflecting the assumption of no second-round effects from the recent rise in energy prices. Wage growth is also a little lower than the central projection. These also reflect a greater drag from slack on inflationary pressures, as demand is weaker than in the central projection.

In the adverse scenario, CPI inflation rises well above the central projection, peaking at 4.5% in 2027 Q2. That largely reflects the direct effects from substantially higher energy prices (Chart 3.4, orange bars). Thereafter, CPI inflation and inflation excluding energy are expected to be persistently above the central projection, with CPI inflation ending the forecast period at 2.4% (Chart 3.4, right panel). That largely reflects much stronger assumed second-round effects than in the central projection, which contribute a little over 1 percentage point to inflation at their peak (Chart 3.3, right panel). These effects also mean that wage growth peaks at a higher rate than in the central projection at 4.4% in 2027 Q2, well above target-consistent rates (Box A, February 2026 Monetary Policy Report).

Chart 3.3: Relative to the central projection, inflation is higher in the adverse scenario and lower in milder scenario, in part due to second-round effects

Annual CPI inflation and the additional impact on inflation from potential second-round effects in the central projection and scenarios ^(a)

• Sources: ONS and Bank calculations.
• (a) The central projection and scenarios shown here are conditioned on the same market curve for Bank Rate. Further details on conditioning assumptions can be found in Table 3.A and the Projections Databank accompanying this Report. The final projections are for 2029 Q3.

Chart 3.4: The direct contribution from energy prices to CPI inflation is a key contributor to the different inflation outcomes across the central projection and scenarios

Annual CPI inflation, CPI inflation excluding energy and direct contribution of energy to CPI inflation across the central projection and scenarios ^(a)

• Sources: ONS and Bank calculations.
• (a) The central projection and scenario shown here are conditioned on the same market curve for Bank Rate. Further details on conditioning assumptions can be found in Table 3.A and the Projections Databank accompanying this Report. The final projections are for 2029 Q3.

Activity and slack in the economy

In the central projection, UK GDP growth is expected to remain subdued over 2026 and early 2027, as the energy shock weighs on real income growth, resulting in weak household spending growth. Tight financial conditions are also assumed to exert a drag on the economy over this period, in part reflecting the recent rise in market interest rates (Box F). GDP growth is expected to pick up from the second half of 2027 as the drag from lower real incomes fades, boosting consumption. Underpinning this is an expected fall in the saving ratio from a little under 9% to around 7.5% at the end of the forecast period. Four-quarter UK GDP growth is expected to be 1.6% at the end of the forecast period.

In the central projection, the margin of spare capacity in the economy is projected to widen slightly to -1.3% in 2026 Q4, before narrowing gradually thereafter (Chart 3.5, aqua line). The near-term widening in slack in part reflects the drag on demand from higher energy prices described above. Restrictive monetary policy, which is judged to be weighing on demand, is also pushing down the output gap in the near term. The output gap begins to narrow from the start of next year as the drag from restrictive monetary policy is expected to fade. The overall stance of fiscal policy, (Box D of the February 2026 Monetary Policy Report), is expected to exert an increasing drag on the output gap throughout the forecast period.

In the milder scenario, four-quarter UK GDP growth is projected to trough at 0.7% in 2027 Q1 and growth rates are projected to be a little lower on average than in the central projection. The output gap is slightly more negative at its trough relative to the central projection (Chart 3.5, purple line), reflecting a weaker path for consumption growth and a higher saving rate.

In the adverse scenario, activity is weaker than in the central projection, with four-quarter GDP growth troughing at 0.6% in 2027 Q2. The sustained rise in energy prices acts as a substantial and persistent terms of trade shock, reducing households’ purchasing power and increasing firms' costs. As a result, the output gap is around 0.2 percentage points more negative than in the central projection (Chart 3.5, orange line) on average over the forecast period, and the unemployment rate slightly higher.

Chart 3.5: The output gap is wider in the adverse and milder scenarios relative to the central projection

Level of the output gap in the Central projection, Milder and Adverse scenario ^(a)

• Sources: ONS and Bank calculations.
• (a) The central projection and scenarios shown here are conditioned on the same market curve for Bank Rate. Further details on conditioning assumptions can be found in Table 3.A and the Projections Databank accompanying this Report. The final projections are for 2029 Q3.

3.3: Model-based policy simulations

The central projection and scenarios described above are conditioned on the market curve for interest rates; if the assumptions underlying any particular projection or scenario came to pass, the appropriate stance of policy would likely vary from that path. Simple policy rules can provide information about the effects of alternative monetary policy stances for different scenarios.

The market curve captures both expectations about the future path of Bank Rate and risk premia (Box F). The policy rules presented here should also be interpreted as exploring alternative overall policy stances, comparable to the stance implied by the market curve, rather than a path for future Bank Rate decisions. The MPC discussed two alternative model-based paths for the central projection, as well as for the milder and the adverse scenario.

For the central projection, staff’s illustrative model-based projections, which balance the speed at which inflation is returned to target with avoiding undesirable volatility in output, are similar to the market curve over the coming year but lower after that (Chart 3.6). On average, they point to a looser overall policy stance than implied by the market curve. Under this alternative stance, inflation would return to target in 2028 Q1 and then stay around the target – rather than slightly undershooting it – and the output gap would close more quickly. A similar policy stance is suggested by a contemporaneous Taylor-type rule that excludes the direct effects of energy price changes but responds to indirect and second-round effects.

Chart 3.6: The economic outlook in the central projection would be consistent with a looser policy stance than implied by the market curve

Central projection under the market curve, staff’s illustrative model-based projections, and a contemporaneous non-energy Taylor-type rule ^(a)

• Sources: Bank of England and Bloomberg Finance L.P.
• (a) The interest rate paths shown are Bank Rate up to 2026 Q2 and subsequently the OIS curve or alternative curves based on policy simulations up to 2029 Q3. The Projections Databank provides additional detail on the definition of the model-based projections and the simple policy rule shown here. These should not be interpreted as a prescription for how policy is likely to evolve. In these simulations, the paths for inflation and the output gap within the forecast period can also be affected by the evolution of policy paths beyond the forecast horizon.

For the milder scenario, staff’s illustrative model-based projections and a contemporaneous non-energy Taylor-type rule are broadly similar to the market curve over the coming year, but lower after that, and are somewhat lower than for the central projection (Chart 3.7). On average, they point to a materially looser policy stance than implied by the market curve.

Chart 3.7: The economic outlook in the milder scenario would be consistent with a looser policy stance than in the central projection

Milder scenario under the market curve, staff’s illustrative model-based projections, and a contemporaneous non-energy Taylor-type rule ^(a)

• Sources: Bank of England and Bloomberg Finance L.P.
• (a) The interest rate paths shown are Bank Rate up to 2026 Q2 and subsequently the OIS curve or alternative curves based on policy simulations up to 2029 Q3. The Projections Databank provides additional detail on the definition of the model-based projections and the simple policy rule shown here. These should not be interpreted as a prescription for how policy is likely to evolve. In these simulations, the paths for inflation and the output gap within the scenario period can also be affected by the evolution of policy paths beyond the scenario horizon.

For the adverse scenario, staff’s illustrative model-based projections suggest that a tighter policy stance than implied by the market curve would help to bring inflation back towards the target more quickly (Chart 3.8, left panel), although at the cost of a larger output gap (Chart 3.8, middle panel). That is because the scenario embodies persistent and material second-round effects which policy would need to act to offset if they came to pass. To ensure that inflation returned to target within the scenario period, an even tighter stance than implied by the illustrative model-based projection or the contemporaneous non-energy Taylor-type rule would be needed, although that would also be associated with even more slack.

Chart 3.8: Policy would need to be materially tighter in the adverse scenario to ensure that inflation returns to the 2% target in the medium term

Adverse scenario under the market curve, staff’s illustrative model-based projections, and a contemporaneous non-energy Taylor-type rule ^(a)

• Sources: Bank of England and Bloomberg Finance L.P.
• (a) The interest rate paths shown are Bank Rate up to 2026 Q2 and subsequently the OIS curve or alternative curves based on policy simulations up to 2029 Q3. The Projections Databank provides additional detail on the definition of the model-based projections and the simple policy rule shown here. These should not be interpreted as a prescription for how policy is likely to evolve. In these simulations, the paths for inflation and the output gap within the scenario period can also be affected by the evolution of policy paths beyond the scenario horizon.

All of the illustrative policy paths described above assume that monetary policy makers know which scenario is going to unfold with certainty. In reality, policymakers are likely to want to set policy to mitigate the outcomes that may occur across a range of possible scenarios given current uncertainties. As a result, their preferred policy stance is likely to depend on the likelihood they attach to different potential paths for the outlook.

Policymakers who judge that, relative to the central projection, outcomes with higher inflation may be more likely in the current environment than lower inflation outcomes, may want to set somewhat tighter policy to lean against such risks. Because monetary policy affects the economy with a lag, policy may need to pre-emptively lean against second-round effects before their exact extent is evident in the data. A staff analysis suggests that the costs in terms of a quadratic loss function of leaning against upside risks that fail to materialise can be smaller than the potential costs of leaning too little against upside risks. The benefits in terms of reducing the risk of higher inflation have to be judged, however, against the costs in terms of lower activity in the economy and the risk of inflation undershooting the target.