What to expect from UK interest rates, inflation, and taxes heading into 2026
The National Institute of Economic & Social Research (NIESR) has published its economic outlook heading into 2026, with the group forecasting green shoots in the economic months.
Speaking first on the November Budget, the NIESR said Chancellor Rachel Reeves should use the forthcoming Autumn Budget to create a bigger fiscal buffer and set debt on a clearly declining path.
“We believe the aim should be to build a buffer of at least £30 billion on top of the OBR’s estimated gap, which insures against future shocks and avoids a cycle of repeated fiscal resets.
“Greater stability would help to lower policy uncertainty, supporting both business investment and consumer confidence. This would likely kickstart the virtuous feedback loop that the UK economy so badly needs.”
Bringing debt under control
However, the real challenge goes beyond the fiscal rule, and the key issue is debt sustainability, it said.
“With the real interest rate now exceeding the growth rate of the economy, stabilising the debt-to-GDP ratio requires persistent primary surpluses of around 1% of GDP, and larger surpluses to bring debt down.
“Without such an adjustment, debt dynamics act as a ratchet: each new shock lifts the ratio higher, and without determined consolidation, it never falls back.”
Five years on from the pandemic, this is the moment to start the process of bringing the debt ratio down, it said.
“If we don’t, we risk losing the capacity to respond to future crises, limiting our ability to invest, and leaving the economy more exposed to inflation and to market pressures. This Budget must be about more than meeting a set of rules. It must be about putting stability first – restoring resilience and rebuilding confidence in the UK’s public finance.”
GDP forecast to grow – with inflation stabilising
Against this backdrop, the NIESR now forecasts GDP growth of 1.5% in 2025 – slightly above the estimated long-run trend of 1.25% – before easing back to trend in 2026 and 2027.
“We expect inflation to fall to 2.7% in the second quarter of 2026 and to reach the 2% target by the third quarter of next year. We believe the MPC will keep rates on hold on Thursday, with a 25-basis-point rate cut in February 2026, followed by a further cut to 3.5% – our estimate of the natural nominal interest rate (r*) – later in the year.”
Debt and tax
Niesr said it believes the UK’s independent fiscal watchdog, the Office for Budget Responsibility, OBR, will predict a smaller deficit of around £20 billion when its latest forecasts are published alongside the Budget.
But Niesr is calling on the chancellor to aim for a buffer of at least £30 billion on top of this to help future-proof the finances against further shocks, which would still leave her needing to find £50 billion.
It said the Chancellor will likely need to break her manifesto pledge and increase income tax, rather than ‘messing around’ with changes to marginal taxes, which it argues would be more damaging to the economy in the long run.
Niesr said a 2p rise on the 20% basic rate of income tax was expected to be the minimum needed to repair Britain’s battered public finances, raising around an extra £20 billion.
A 5p rise on the 40% higher rate would add a further £10 billion, with around £500 million from a similar hike to the upper band, it said.
