Monetary Policy Report - February 2026

Monetary Policy Summary

At its meeting ending on 4 February 2026, the Monetary Policy Committee voted by a majority of 5–4 to maintain Bank Rate at 3.75%. Four members voted to reduce Bank Rate by 0.25 percentage points, to 3.5%.

Although above the 2% target currently, CPI inflation is expected to fall back to around the target from April, owing to developments in energy prices including from Budget 2025. Reflecting the impact of monetary policy, and consistent with evidence of subdued economic growth and building slack in the labour market, pay growth and services price inflation have generally continued to ease. The risk from greater inflation persistence has continued to become less pronounced, while some risks to inflation from weaker demand and a loosening labour market remain.

Monetary policy is being set to ensure that CPI inflation not only reaches 2% but remains sustainably at that level in the medium term, which involves balancing the risks around achieving this. The restrictiveness of policy has fallen as Bank Rate has been reduced by 150 basis points since August 2024. On the basis of the current evidence, Bank Rate is likely to be reduced further. Judgements around further policy easing will become a closer call. The extent and timing of further easing in monetary policy will depend on the evolution of the outlook for inflation.

Monetary Policy Overview

The Monetary Policy Committee’s (MPC’s) job is to ensure that inflation continues to fall back to the 2% target and then stays there. Monetary policy has already helped to bring inflation back towards the target over the past three years. That has allowed the MPC to make monetary policy less restrictive by cutting Bank Rate six times since August 2024.

CPI inflation was 3.4% in December. Wage and price pressures have continued to moderate but remain above rates consistent with meeting the inflation target in the medium term.

Recent developments provide more confidence that inflation is on track to return close to the 2% target soon but the MPC needs to ensure that it stays at the target.

The MPC’s policy decisions continue to be shaped by how two big forces play out. On the one hand, the period of high inflation could have affected the way wages and prices are determined in the economy, creating more persistent inflationary pressure. On the other hand, weaker labour demand and subdued household spending could take inflation below the target. Monetary policy is being set to balance these risks so that Bank Rate is neither too low nor too high.

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

Key policy judgement 1

The risk from greater inflation persistence has continued to become less pronounced, while some risks to inflation from weaker demand and a loosening labour market remain.

The recent experience of high inflation could still be affecting wages and prices. This could create more persistent inflationary pressure, requiring tighter monetary policy than otherwise. Services price inflation and wage growth still need to fall further for the MPC to be confident that inflation will return to the target and stay there (Box A: Estimates of ‘target-consistent’ wage growth). In addition, weak productivity growth could put upward pressure on companies’ costs (Box C: The outlook for productivity growth).

However, other developments and new analysis suggest that the risk of greater inflation persistence has continued to diminish. The outlook for inflation over the next six months is notably lower than expected in November. That mainly reflects developments in energy prices, including the impact of measures announced in Budget 2025 (Box D: Budget 2025 and the impact of fiscal policy on the economy). Lower inflation in coming months should feed through into lower inflation expectations among households and businesses, reducing the risk that high inflation becomes self-fulfilling (Box B of the November 2025 Monetary Policy Report). And, while wage growth may only be falling slowly, new evidence provides reassurance that structural changes in wage-setting will not keep adding to inflationary pressures (Box B: Heterogeneity in wage-setting behaviour among UK firms).

While concerns about the upside risk from greater inflation persistence continue to become less pronounced, some risks to the outlook for inflation from weaker demand and a loosening labour market remain. This could lead to a substantial margin of spare capacity, causing inflation to settle below the 2% target unless monetary policy were loosened further. Despite past reductions in Bank Rate, the household saving rate remains above historical levels. That could indicate that households are more cautious following the recent shocks to their finances, and that spending growth will remain weak (Box D of the November 2025 Monetary Policy Report). Labour market conditions have loosened (Section 1.2) and any further weakening in labour demand could lead to a more pronounced rise in unemployment (Box E of the November 2025 Monetary Policy Report).

Key policy judgement 2

On the basis of the current evidence, Bank Rate is likely to be reduced further. Judgements around further policy easing will become a closer call.

Monetary policy is being set to ensure that inflation not only reaches the 2% target but remains sustainably at the target in the medium term. Monetary policy continues to weigh on inflation and activity (Box E: Monitoring the transmission of monetary policy with interest rate-sensitive indicators). If inflationary pressures continue to ease, Bank Rate is likely to be reduced further. Judgements around further reductions will become a closer call.

As always, the extent and timing of further easing in monetary policy will depend on the evolution of the outlook for inflation. On the one hand, cutting Bank Rate too quickly or by too much could lead to inflationary pressures persisting, requiring policy to change course. On the other hand, waiting too long to ease policy could come at the cost of a sharper downturn in activity, and subsequently inflation, requiring greater policy easing later on to ensure inflation returns sustainably to the target. With uncertainty around how precisely a neutral level of Bank Rate can be estimated, slowing the pace of further easing could provide space to gain assurance about how the risks are evolving.

The central projection described in Section 3.1 provides a reasonable baseline for how the majority of the MPC judges the economy is likely to evolve if neither of the remaining risks around inflation persistence and demand weakness materialise to a meaningful degree. Section 3.2 sets out how the economy could evolve differently to the central projection, including by updating the scenarios from the November Report. These scenarios also help the MPC to consider how well different monetary policy responses might perform in achieving the MPC’s objective of low and stable inflation at the 2% target.

At this meeting, the MPC voted to maintain Bank Rate at 3.75%. More evidence is needed on how the risks to the medium-term outlook are evolving before cutting Bank Rate further.

1: Current economic conditions

1.1: Inflation

Headline CPI inflation was 3.4% in December, slightly lower than expected at the time of the November Report.

CPI inflation has fallen by 0.4 percentage points from its recent peak in September (Chart 1.1) and was 0.1 percentage points below expectations at the time of the November Report. The downside news relative to November largely reflects lower food and services price inflation.

Despite the recent slowing, inflation remains above the 2% target. That in part reflects unusually large increases in administered prices such as Vehicle Excise Duty and higher water bills. These are currently estimated to be contributing around 0.5 percentage points to the inflation overshoot, based on the difference between their current and historical contributions (Chart 1.3). Food, beverage and tobacco inflation is estimated to be contributing a further 0.5 percentage points to the inflation overshoot. Elevated labour cost growth is also pushing up inflation, particularly for services which tend to be labour intensive.

Chart 1.1: CPI inflation was 3.4% in December

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 2025, which do not sum to 100% due to rounding. Data are shown to December 2025. Component-level Bank staff projections are shown from January 2026 to June 2026. The projection also accounts for expected changes in CPI weights in 2026. The food component is defined as food and non-alcoholic beverages. Fuels and lubricants estimates use DESNZ petrol price data for January 2026 and are then projected based on the sterling oil futures curve.

Headline CPI inflation is projected to slow much more than expected in the November Report, to 2.1% in 2026 Q2, largely reflecting measures announced in Budget 2025.

CPI inflation is expected to fall to 2.1% in 2026 Q2, a 0.7 percentage point greater fall than anticipated in the November Report (Chart 1.2). That news largely reflects the energy bills package announced in Budget 2025 (Box D), which, alongside a fall in wholesale gas prices, is expected to result in a decline in the Ofgem price cap in April to £1,616 from £1,758. That fall in the contribution of utility prices represents around one third of the overall expected decline in CPI inflation in the first six months of 2026 (Chart 1.1).

Chart 1.2: Lower household energy prices mean that CPI inflation is projected to slow much more than expected in the November Report

News to CPI inflation relative to the November 2025 projection ^(a)

• Sources: ONS and Bank calculations.
• (a) Bank staff’s short-term inflation forecast only extends for six months. For that reason the Q2 ‘Non-energy’ bar represents the difference between the February Report short-term forecast shown in Chart 1.1 and the November Report medium-term central projection, excluding the effects of energy. The ‘Energy due to Budget’ bars represent the estimated impact of the energy bills package and the extension of the fuel duty cut. The ‘Non-Budget energy’ bar represents expected falls in utility price inflation due to non-Budget related factors such as falls in wholesale gas prices.

A reduction in the contribution from other changes in administered prices, regulated prices and indirect taxes (AR&T) is also expected to support the near-term disinflation process. Bank staff judge that the overall contribution of AR&T will fall to around its historical average in 2026 Q4 (Chart 1.3).

Chart 1.3: The estimated contribution of AR&T to CPI inflation is expected to be around its historical average by 2026 Q4

Estimated contributions of AR&T to CPI inflation (excluding major VAT changes) ^(a)

• Sources: ONS and Bank calculations.
• (a) These data exclude major VAT changes in 2008–11 and 2020–22, the Eat Out to Help Out scheme and the Energy Price Guarantee effective 2022–24. The diamond includes the impact of the energy bills package announced in Budget 2025 which is worth a little over 0.2 percentage points. Around 12% of the basket is estimated to be associated with AR&T changes. Given the variability of the contribution of AR&T over the past, the long-term average might not be a good guide to future trends. The latest data are for December 2025 and the diamond is for 2026 Q4.

A broad-based slowing in other components is expected to account for the remaining fall in CPI inflation over 2026 H1. That in part reflects the continued slowing in wage growth and a fading impulse from the 2025 increase in employer NICs. Continued falls in some indicators of external costs are also expected to support disinflation in the near term.

Bank staff project that core goods inflation will fall to 0.9% by June 2026, slightly above its 2012–19 average. Services and food price inflation are expected to moderate to 3.3% and 2.4% respectively, close to, but still slightly above, their 2012–19 averages.

Global price pressures remain subdued.

Indicators of global price pressures have been weak, reflecting falling energy prices, domestic demand weakness in China and the effects of higher US tariffs. Chinese export prices fell by over 2% in the year to 2025 Q3, which may be partly due to trade diversion, as well as continuing demand weakness in China. This, alongside weakness in euro-area export prices and the US dollar, has meant that aggregate UK import prices have been fairly flat over 2025 and import price inflation is expected to remain subdued.

Spot oil prices were around $66 a barrel in the 15 UK working days to 26 January, a little higher than in the period leading up to the November Report. The UK gas futures curve has fallen by around 13% on average over the same period.

Indicators of food price inflation have eased. Agricultural commodity prices for items such as cocoa and cattle had surged in 2025 (Box E of the August 2025 Monetary Policy Report), pushing up consumer prices, but these have since fallen from their recent peaks. Further down the supply chain, producer output prices have been flat since August. Contacts of the Bank’s Agents report that food price inflation has peaked and should moderate further from here (Agents’ summary of business conditions – February 2026 (ASBC)).

Wage growth has continued to moderate.

Annual private sector regular AWE growth slowed to 3.6% in the three months to November, down from 4.4% in the three months to August and 0.1 percentage points below the projection in the November Report. That fall was partly due to mechanical base effects, as strong monthly growth rates from last year dropped out of the annual comparison, but timelier measures of pay growth have also cooled. Bank staff estimates that abstract from volatile movements in AWE indicate a three-month annualised growth rate of around 3¼%. Alternative indicators generally also suggest continuing moderation, though to differing degrees. An estimate of private sector median pay based on HMRC RTI data implies pay growth of 4.6% in December 2025, down from 5.0% in September 2025.

The recent slowing in wage growth has brought it closer into line with the rate implied by its key determinants, following a period of unexplained strength. A model estimated on pre-Covid pandemic data suggests that the estimated rate of wage growth in 2025 Q4 can be largely explained by movements in inflation expectations, productivity and the margin of slack in the economy (Chart 1.4). Box B discusses reasons for the recent excess strength in wage growth shown in the gold bars and implications for the wage outlook.

Chart 1.4: Wage growth is broadly as expected based on a simple model of its key determinants

Contributions to estimated annual private sector regular pay growth ^(a)

• Sources: Barclays, Citi/YouGov, ONS and Bank calculations.
• (a) Wage equation based on Yellen (2017). Short-term inflation expectations are based on the Barclays Basix Index and the YouGov/Citigroup one-year ahead measure of household inflation expectations. Slack is based on the MPC’s estimate of the unemployment gap. Productivity growth is based on market sector productivity growth per head. Values may not sum due to rounding. The unexplained component is the residual. The final data point is 2025 Q3 and the estimate for 2025 Q4 is a staff projection.

In contrast to the slowing in the private sector, public sector regular pay growth rose to 7.9% in the three months to November. That in part reflects some public sector pay rises being implemented earlier in 2025 than in 2024. The risk that high public sector pay growth spills over to the private sector is likely to be low, in part because job flows between the two sectors are currently below their pre-pandemic averages.

Some further easing in wage growth is expected in 2026 as labour market conditions continue to loosen.

The Agents’ pay survey suggests that basic private sector pay settlements will average 3.4% over 2026, broadly in line with expectations at the time of the November Report, and down from an average actual pay settlement of 4.0% in 2025 (ASBC – February 2026). The distribution of expected pay settlements has shifted lower, with over 70% of settlements now in the 2%–4% range (Chart 1.5). Firms reported that current and expected inflation were the most important factors pushing up pay settlements. Firms’ ability to recruit and retain staff remained important, but less so than in 2025, consistent with the continued loosening in the labour market.

Chart 1.5: The distribution of expected pay settlements in the Agents’ pay survey has shifted left

Fitted kernel density and median survey expectations ^(a)

• Sources: Bank of England Agents and Bank calculations.
• (a) Kernel density estimates of the distribution of one year ahead expected pay settlements from the Agents’ pay survey. Curves are smoothed representations of the underlying survey responses. Each line shows the distribution of responses for the year indicated. Dashed lines represent the median survey expectations for each year. The latest data are the 2026 expected pay settlements.

Other forward-looking indicators of pay growth are also consistent with some further easing. Firms responding to the DMP Survey, for example, expect wage growth to fall by 0.7 percentage points to 3.7% by 2026 Q4, and then a little further in the three months to January 2027.

A smaller increase in the NLW should help to support the disinflation process. The forthcoming increase in April 2026, of 4.1%, is expected to have a negligible impact on aggregate wage growth, in contrast to the 0.2 percentage points boost to wage growth estimated in 2025, when the NLW was increased by 6.7%. Contacts of the Bank’s Agents report that lower pressure from the NLW is expected to reduce labour cost growth this year.

Bank staff’s central projection is for a further slowing in AWE growth, to 3.2% by 2026 Q2 (Chart 1.6). The projection is informed by the 3.4% estimate for basic settlements from the Agents’ pay survey, as well as an expectation that pay drift will weigh on AWE pay growth. Pay drift reflects the extent to which aggregate pay growth diverges from pay settlements and can be positive when firms are under pressure to raise pay to retain or attract workers. As the labour market has loosened (Section 1.2), pay drift has turned slightly negative. Firms’ average wage expectations in the DMP Survey could suggest upside risks to this projection, however.

Chart 1.6: Wage growth has fallen and is expected to moderate somewhat further

Measures of private sector wage growth and pay settlements ^(a)

• Sources: Bank of England Agents, Brightmine, CIPD, DMP Survey, Incomes Data Research, Labour Research Department, ONS and Bank calculations.
• (a) AWE private sector regular pay shows the ONS measure of private sector regular AWE growth (three-month average on same three-month average a year ago). The DMP expected pay series is a three-month average, measuring pay growth for the year ahead. It measures total wage growth per worker. The other measures capture basic pay settlements which may differ from AWE growth due to pay drift. The latest AWE data are for the three months to November, while the aqua diamonds are quarterly projections for 2025 Q4–2026 Q2. The DMP expected pay growth is for the three months to December. The Agents’ pay survey diamond shows respondents’ expected average pay settlements in 2026, weighted by employment and sector. The Bank of England settlements database is a 12-month average to December 2025. The Brightmine and CIPD data are three-month averages to December 2025.

Measures of underlying services inflation eased over 2025 as a whole but edged up slightly in the most recent data.

Measures of underlying services inflation have eased over the past year, and monthly annualised inflation rates are currently at around 4% (Chart 1.7). These measures ticked up slightly in the most recent data, partly reflecting a pickup in restaurant and café prices which rose by an annualised rate of 5% on the quarter. In turn that is probably the consequence of lagged pass-through of last year’s rise in food price inflation, which is expected to moderate in the coming months.

The decline in wage growth and a fading impact from higher employer NICs are expected to support a further easing in annual services inflation, to 3.3% by June 2026. That easing is expected to be broad-based, with the trimmed-mean measure of underlying services inflation (Chart 1.7, orange line) expected to fall to around 3 ½% over the next few months, leaving both measures slightly above the range that is likely to be consistent with CPI inflation at target. There is a risk that pass-through from lower wage growth to services inflation is more limited if firms seek to rebuild their margins over and above their costs (Box A of the November 2025 Monetary Policy Report). 39% of firms responding to the DMP Survey said they expected to rebuild margins in the year ahead. But contacts of the Bank’s Agents expect a limited degree of margins rebuild over the next year, mainly reflecting continuing weakness in demand (ASBC – February 2026).

Chart 1.7: Underlying services inflation measures have edged up slightly

Measures of three-month average monthly annualised services price inflation ^(a)

• Sources: ONS and Bank calculations.
• (a) Measures shown are three-month averages of seasonally adjusted monthly annualised inflation. 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 December 2025.

Inflation expectations

Households’ and firms’ inflation expectations remain elevated.

Short-term household inflation expectations remain above their long-term averages (Chart 1.8, aqua lines in left panel). The Citi one-year-ahead measure stood at 3.8% in January, down from 4.2% in October but around 2 standard deviations above its 2010–19 average. The equivalent measure from the Inflation Attitudes Survey fell by 0.1 percentage points to 3.5% in 2025 Q4 but is also above its historical average. Medium-term household measures remain elevated.

Household inflation expectations are above the range implied by their past relationships with other economic variables. Short-term expectations tend to be sensitive to developments in spot consumer price inflation (Rowe (2016)), however. Consequently, as headline inflation falls in coming months, short-term inflation expectations are expected to moderate towards their pre-pandemic averages, although there are risks around this (Section 3.2 and Box B of the November 2025 Monetary Policy Report).

Firms’ inflation expectations also appear somewhat elevated. One-year-ahead CPI expectations of firms responding to the DMP Survey in the three months to January were 3.2% on average, down from 3.4% in the three months to October, while three-year-ahead expectations were unchanged at 2.9% (Chart 1.8, right panel). Firms’ average two-year-ahead CPI expectations in the Deloitte CFO Survey for 2025 Q4 were 2.5%, a little above their 2014–19 average of 2.2%.

The own-price expectations of firms responding to the DMP Survey in the three months to January were 3.5% on average for the year ahead, compared with realised price growth of 3.7%, implying little disinflation over the coming year. But firms’ own price expectations tend to respond to realised inflation and so should fall back as CPI inflation falls in coming months.

Medium-term inflation expectations implied by financial markets, such as the five-year, five-year forward inflation swap rate, have risen slightly since the November Report. The median respondent to the latest Market Participants Survey expected CPI inflation one year ahead to be 2.2%, a little lower than the 2.3% reported in the November Survey, and to be 2% at the three-year horizon.

Chart 1.8: Households’ and firms’ inflation expectations have eased a little but remain elevated

Survey-based measures of household ^(a) and business inflation expectations ^(b)

• Sources: Citigroup, DMP Survey, YouGov and Bank calculations.
• (a) Data shown 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?’. Dashed lines represent the series averages over 2010–19. The latest data points are for January 2026.
• (b) Data shown are from the DMP Survey and are based on three-month averages of responses 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 January 2026. The DMP Survey data have a short back-run, so no historical averages are shown.

1.2: Activity

Domestic demand

Underlying GDP growth remains subdued, consistent with weak growth in potential supply and a small drag from past monetary tightening and uncertainty.

Underlying GDP is estimated to have grown by 0.1% in 2025 Q4, down from 0.2% in Q3 and slightly lower than headline GDP growth (Chart 1.9). These growth rates are a little lower than estimated potential supply growth, although that has also been subdued in recent quarters.

Market sector output growth has been even weaker than underlying growth over the past 18 months, as past monetary policy restrictiveness and uncertainty, in part relating to Budget 2025, have weighted on activity (Chart 1.10). Public sector output growth has been stronger and is expected to remain robust.

Chart 1.9: Underlying GDP growth remains subdued, but is expected to pick up slightly

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 2025 Q3. The diamonds for 2025 Q4 and 2026 Q1 show Bank staff projections. Underlying GDP growth estimates are from a survey indicator model based on a Staggered-Combination MIDAS approach (Moreira (2025)). The orange diamonds to 2025 Q3 show in-sample fitted values of the survey indicator model, and diamonds for 2025 Q4 and 2026 Q1 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.

Underlying growth is expected to pick up slightly in 2026 Q1, to 0.2%. This is broadly consistent with the S&P Global Composite UK PMI output index, which picked up in January to around its historical average. Agents’ contacts continue to expect subdued growth throughout 2026, citing weak confidence and subdued global demand (ASBC – February 2026).

Chart 1.10: Weakness in market sector output growth has been offset by strong growth in public sector output

Changes in sectoral GDP since December 2023 ^(a)

• Sources: ONS and Bank calculations.
• (a) Public sector output includes public administration and defence, education, and human health and social work activities. Market sector output is total GDP excluding public sector output. The final data points are for November 2025.

Household consumption growth has been subdued but picked up in 2025 Q3.

Past rises in interest rates have been a major driver of weak consumption growth in recent years, although Bank staff judge that these effects may be starting to wane (Box E). The household saving ratio fell to 9.7% in 2025 Q3 (Chart 1.11), reflecting lower real income growth and a pickup in consumption growth. Initial estimates of the household saving ratio are often subject to substantial revision, however.

Despite the most recent fall, the saving ratio remains higher than in the decade prior to the pandemic. A large part of that is likely to reflect past monetary policy restrictiveness. Increases in the effective interest rate on the stock of UK mortgages are continuing to reduce household cash flows, for example, which is weighing on consumption. Past rises in inflation and heightened uncertainty could also be contributing to a higher saving ratio by causing a structural shift in households’ saving preferences (Box D of the November 2025 Monetary Policy Report). There continues to be little evidence that households are saving more for precautionary reasons, however. While evidence from the Bank of England/NMG survey points to higher economy-wide unemployment expectations, households’ own perceived job-loss risk remains low on average. And, whereas a pickup in flows of liquid deposits could signal that households are saving for precautionary reasons, the mix of liquid and illiquid deposits in households’ deposit flows has been similar to historical trends.

Evidence from spending indicators suggests that consumption growth will remain weak in the near term. Retail sales volumes fell overall in 2025 Q4, and GfK consumer confidence remained subdued. Contacts of the Bank’s Agents expect weak consumer confidence to persist into early 2026. Real disposable incomes are expected to continue to rise, although the freeze in income tax thresholds will limit the support to household spending. While further increases in effective mortgage rates are expected to continue to weigh on spending growth, waning effects of past monetary policy restrictiveness are expected to boost consumption growth overall in coming quarters.

Chart 1.11: Despite a small decline in 2025 Q3, the household saving ratio remains elevated relative to past averages

Household saving ratio ^(a)

• Sources: ONS and Bank calculations.
• (a) Saving as a percentage of total available household resources. The ONS series is NRJS. The final data point shown is for 2025 Q3.

Business investment growth has been reasonably robust, although investment intentions have been weak.

Business investment was revised up significantly as part of Blue Book 2025 and was relatively robust at 2.7% in the year to 2025 Q3 (Chart 1.12), driven by investment in information communications technology (ICT) and machinery. Recent business investment growth will have been supported by declines in firms’ external financing costs (Section 1.3). And contacts of the Bank’s Agents report that the cost of labour relative to capital has risen, raising incentives to invest in labour-saving technologies (Box C). As the lagged effects of past increases in interest rates continue to wane and some substitution from labour to capital continues, that is expected to support business investment growth in coming quarters.

Subdued investment intentions could pose a downside risk to the near-term outlook for business investment growth, however. Investment intentions fell sharply in 2024 Q4 and have remained weak (Chart 1.2). Contacts of the Bank’s Agents note that the wider economic outlook is not conducive to investment (ASBC – February 2026). And while some firms are resuming delayed investment projects, these are mainly intended to increase efficiency and reduce costs.

Chart 1.12: Business investment growth has been reasonably robust, although investment intentions surveys point to weakness

Four-quarter business investment growth and range of survey indicators of investment intentions ^(a)

• Sources: Bank of England Agents, BCC, CBI, ONS and Bank calculations.
• (a) Survey measures are scaled to match the mean and variance of four-quarter business investment growth since 2000. Measures of the Bank’s Agents (split by manufacturing and services), the BCC (non-services and services) and the CBI (manufacturing, distribution, financial services and business/consumer/professional services) are weighted together using shares in real business investment. The Agents’ measure indicates companies’ intended changes in investment over the next 12 months, with the latest available observation for each quarter shown. The BCC measure is the net percentage balance of respondents reporting that they have increased planned investment in plant and machinery and the data are not seasonally adjusted. The CBI measure is the net percentage balance of respondents reporting that they have increased planned investment in plant and machinery for the next 12 months. The final data are for 2025 Q3.

Labour market

Underlying employment has been flat.

Underlying employment growth has been around zero over the past year (Chart 1.13, left panel). That is weaker than subdued GDP growth would have implied, due to cost pressures from higher employer NICs and the NLW. The flash December HMRC payrolls data continue to point to weak hiring momentum, and survey evidence from the DMP and S&P Global Composite UK PMI suggests that employment growth remains subdued. Contacts of the Bank’s Agents report headcount reductions in sectors most exposed to discretionary consumer spending and to the NLW and NICs increases.

LFS employment growth rose slightly to 0.2% in the three months to November (Chart 1.13, left panel). Notwithstanding the latest uptick, recent outturns have brought the official measure more in line with the subdued growth implied by alternative indicators as LFS sample sizes have risen.

Aggregate employment growth is expected to remain muted in the near term. Survey evidence from the DMP and S&P Global composite UK PMI continues to indicate subdued hiring intentions.

Chart 1.13: Underlying employment has been flat and unemployment continues to rise

Measures of underlying and LFS employment growth; unemployment rate and near-term projections ^{(a) (b)}

• Sources: Bank of England Agents, DMP Survey, HMRC, KPMG/REC UK Report on Jobs, Lloyds Business Barometer, ONS, S&P Global and Bank calculations.
• (a) Bank staff’s indicator-based measure of underlying employment growth is constructed using a dynamic factor model following the approach of Doz et al (2011). The model extracts a common component from monthly survey indicators, capturing comovements across series. The common component is scaled to align with LFS employment growth between 2000–19. The shaded area represents the 95% confidence interval. The latest data are for January 2026 for the estimate of underlying employment based on survey data and for the three months to November 2025 for the LFS.
• (b) The latest data are for the three months to November 2025. The diamonds show Bank staff projections for the three months to December 2025 and March 2026 respectively. 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).

Labour market conditions have loosened further…

Consistent with continuing weakness in employment growth, the labour market appears to have loosened further. The unemployment rate remained at 5.1% in the three months to November (Chart 1.13, right panel) and measures of recruitment difficulties have eased. The LFS redundancy rate remains elevated relative to the last few months (Chart 1.14, orange line), although contacts of the Bank’s Agents report that firms have been managing headcount mainly through natural attrition rather than widespread redundancies (ASBC – February 2026).

Vacancy levels have stabilised since mid-2025, with a small pickup in the November data. But the rise in unemployment means that the vacancy to unemployment (V/U) ratio, one measure of labour market slack, has fallen further below its estimated equilibrium level. And net additional hours desired by workers as a proportion of average hours worked, a measure of under-employment, fell but remain elevated relative to their historical average (Chart 1.14, aqua line).

The composition of the rise in unemployment is also consistent with labour market slack having increased. Bank staff analysis indicates that short-term unemployment has accounted for nearly half of the recent increase in LFS unemployment since its trough in 2022 Q3. Short-term unemployed workers typically move back into work more quickly, so a greater share of short-term unemployment suggests a larger pool of workers that can be absorbed back into employment relatively easily. Consistent with that, Bank staff estimates suggest that the medium-term equilibrium unemployment rate has increased only slightly, although there are risks around this (Section 3.2).

…and some further loosening is expected in the near term.

The unemployment rate is expected to rise further to 5.3% by mid-2026, a little higher than the central expectation in the November Report. That is consistent with the latest uptick in forward-looking indicators for redundancies, such as HR1 notifications and Google searches for redundancies.

The margin of slack in the economy is judged to have widened slightly further as demand growth has remained subdued.

Consistent with the rise in labour market slack, recent evidence points to a gradual widening in aggregate spare capacity. Survey evidence on capacity utilisation and intelligence from the Bank’s Agents’ contacts suggests that spare capacity within firms has increased further in recent months. And model-based estimates suggest that the economy-wide output gap has widened modestly (Section 3.2).

Chart 1.14: Conditions in the labour market have continued to loosen

LFS redundancy rate and net additional desired hours as a percentage of average weekly hours ^(a)

• Sources: ONS and Bank calculations.
• (a) The orange line is the ratio of the redundancy level for the given quarter to the seasonally adjusted number of employees in the previous quarter, multiplied by 1,000. Latest redundancies data are for the three months to November 2025. The aqua line is the number of net additional desired hours that the currently employed report they would like to work, on average, per week, expressed as a share of average weekly hours. Latest data are to 2025 Q3.

1.3: Global and financial conditions

Global economic activity

Global activity has been more resilient than expected.

Bank staff estimate that the global effective tariff rate on imports into the US is around 17%, 1 percentage point lower than at the time of the November Report. The estimated effective US tariff rate on imports from the UK remains around 9%. Uncertainty over US trade policy has persisted (Section 3.2).

Global activity has been more resilient than expected at the time of the November Report. Bank staff judge that uncertainty associated with past trade policy measures has been smaller than previously assumed. Easier global financial conditions have also supported global activity, while AI-related investment has boosted activity growth in some regions.

UK-weighted world GDP growth is expected to have been 0.4% in 2025 Q4 (Chart 1.15) and is projected to pick up a little over the coming quarters as the expected drag from the impact of tariffs and trade policy uncertainty is offset by a boost from global financial conditions.

Table 1.15: World GDP growth has been more resilient than expected to trade policy developments

UK-weighted world GDP growth and GDP growth in selected countries ^(a)

• Sources: LSEG Workspace and Bank calculations.
• (a) The diamonds show Bank staff projections for UK-weighted world quarterly GDP growth, and for quarterly GDP growth in China, the US and the euro area. The projections are for 2025 Q4 to 2026 Q2 for all of the areas. The preliminary flash estimate for 2025 Q4 euro-area GDP was published after the cut-off for incorporation into the forecast so the data point for that quarter is a projection. 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 market-implied path for Bank Rate was a little lower relative to the lead up to the November Report.

Based on the 15-day average of forward interest rates to 26 January, the market curve implied that Bank Rate would fall to around 3.3% in 2026 H2 (Chart 1.16). The market curve slopes upwards beyond 2026 and reaches 3.7% in early 2029. The median respondent to the Market Participants Survey expected Bank Rate to fall to 3.25% and stay there.

The market-implied paths for US and euro-area policy rates were around 20 basis points higher, on average, over the next three years than in the period leading up to the November Report.

Chart 1.16: The market-implied path for policy rates was a little lower relative to the November Report in the UK

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

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) All data are as of 26 January 2026. The February 2026 curves are estimated based on the 15 UK working days to 26 January 2026. The November 2025 curves are estimated based on the 15 UK working days to 28 October 2025. 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 March 2029.

Overall financial conditions have eased slightly since the November Report.

A financial conditions index constructed by Bank staff suggests that conditions have eased slightly compared with those at the time of the November Report. The sterling ERI appreciated somewhat in the run-up to the February Report. Sterling rose by nearly 1% against the US dollar and around 0.3% against the euro. UK and global equities have generally risen despite volatility linked to global technology company valuations and geopolitical developments.

Since the November Report, 10-year UK government bond yields have fallen a little and are below the peaks observed last year. Recent Bank staff analysis indicates that much of the rise in long-term yields over 2025 was driven by higher term premia. That in turn reflected global geopolitical uncertainty and concerns about fiscal sustainability, with UK-specific evolving gilt-market demand dynamics also having played a role.

Domestic credit conditions

Lending rates have generally fallen following the reductions in Bank Rate and earlier falls in term reference rates, which will support borrowing volumes.

Since their peaks, falls in Bank Rate and term OIS rates have generally passed through to the rates faced by households and corporates in line with historical experience. Rates on new corporate loans have fallen from their peaks, broadly tracking changes in Bank Rate (Chart 1.17, right panel). Mortgage rates have declined further since the November Report, with some products now at their lowest levels for several years (left panel). Quoted personal loan rates have eased slightly, while credit card rates remain close to recent highs, consistent with their historically slower adjustment and an unwind in spreads which had narrowed during the tightening phase. Pass-through to sight deposits remains low and gradual.

Bank lending volumes have continued to pick up, supported by lower lending rates and improved credit supply. Net lending growth to households has continued to increase since November, across both secured lending and consumer credit, although real lending growth remains slightly below its pre-pandemic average. Bank lending to corporates has strengthened, particularly among large firms. And credit availability for both households and corporates has improved over the past year, according to responses to the Bank’s Credit Conditions Survey – 2025 Q4 (CCS). For secured lending, this is consistent with a variety of developments including lenders’ responses to the Financial Conduct Authority’s (FCA) statement on mortgage stress rates in March and the FPC’s update to its Loan to Income (LTI) flow limit Recommendation in 2025 Q2. More generally, the FPC’s decision to lower the system-wide benchmark for Tier 1 capital should provide banks with greater confidence in using their existing capital to support lending.

As the main source of money creation, the recovery in net lending has supported growth in broad money, which reached 5% in the year to December 2025. Stronger growth in money balances could signal upside risks for nominal spending and the inflation outlook, although that signal tends to be strongest over longer windows of time (Box D of the May 2025 Monetary Policy Report).

Chart 1.17: Most household and corporate interest rates continue to track reductions in reference rates

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

• Sources: Bank of England, Bloomberg Finance L.P. and Bank calculations.
• (a) Household loan and deposit rates are based on average quoted rates and business loan rates are based on average effective rates on new lending. 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, while Bank Rate shows month-end numbers. The provisional January 2026 data are shown as diamonds. For quoted rate series and the two-year OIS rate, these are based on average values to 26 January 2026. The provisional data point for Bank Rate is the rate as of 26 January 2026. The final business loan rate data are for December 2025.

2: Topical policy issues

The boxes in this section highlight some of the key pieces of analysis that informed the MPC’s discussions.

3: Outlook and risks

3.1: Central projection

The central projection is based on a staff proposal, which the majority of the MPC agrees is a reasonable baseline. It provides an important input into the MPC’s discussions and policy decision. This projection is, as always, uncertain and the key risks are set out in Section 3.2.

Conditioning assumptions

The February central projection, summarised in Table 3.A and detailed more fully in Annex 1, is conditioned on a range of assumptions (set out in the Report’s Projections Databank). That includes a market-implied path for Bank Rate which falls to around 3¼% by the final quarter of 2026, before rising towards the end of the forecast period, and the Government’s fiscal plans as set out in Budget 2025.

Chart 3.1: CPI inflation is expected to return to the 2% target this year and remain around that rate in the medium term. GDP growth is projected to rise modestly in the medium term, while the unemployment rate is expected to peak later this year

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

• (a) The fan charts depict the probability of various outcomes for GDP growth, the ILO definition of unemployment, and CPI inflation. 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 or purple areas of the fan chart, depicted by the grey 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

CPI inflation was 3.4% in 2025 Q4. It is projected to return to around the 2% target in 2026 Q2 and to remain close to that level over the forecast period. The near-term projection for CPI inflation is significantly lower than in the November Report, largely reflecting lower energy prices including from Budget 2025 (Box D).

Chart 3.2 illustrates the underlying determinants of CPI inflation in the MPC’s central projection over the medium term. The contributions shown in this chart are based on the standard relationships and assumptions used in the Bank’s forecast models, the direct effects of certain tax policy measures, and judgements to capture relevant factors that are missing from the standard modelling toolkit such as the MPC’s previous judgements on inflation persistence (Box F). This approach attributes changes in past and projected inflation to broad economic influences, such as economic slack, that may affect multiple components of inflation.

The expected near-term fall in CPI inflation reflects a lower contribution from energy prices, reflecting the energy bills package introduced in the Budget and lower wholesale gas prices (Chart 3.2, orange bars and Section 1.1). The contributions from administered prices and the pass-through of NICs-related costs are also assumed to dissipate in 2026 Q2 (azure bars and Section 1.1). The contribution from import prices declines over the course of the year (aqua bars) in part due to the expected effects of trade diversion weighing on world export prices (Sections 1.1 and 3.2). In the medium term, these factors make little contribution to the deviation of inflation from the 2% target, although the introduction of mileage‑based charges for electric vehicles is provisionally expected to raise inflation slightly in the final year of the forecast (azure bars).

Chart 3.2: Inflation is expected to slow sharply in 2026 Q2 and to be close to the target over the remainder of the forecast

Percentage point deviation from the 2% inflation target ^(a)

• Sources: ONS and Bank calculations.
• (a) ‘Administered prices, NICs, and electric vehicle (EV) mileage charge’ includes the estimated direct effects of changes to Vehicle Excise Duty, bus fares, VAT on school fees, and water charges. The NICs component represents Bank staff’s allowance for the effects of the recent increase in employers NICs on CPI inflation. The EV mileage charge component relates to the mileage-based charge on electric vehicles announced in Budget 2025. The ‘Energy budget measures’ bars represent the estimated direct effects of the energy bills package and the extension of the fuel duty freeze. The ‘Import prices’ bars includes an MPC judgement on the price of tradables (May 2024 Monetary Policy Report) which has little effect on the profile beyond 2026. The ‘Other’ bars represent other deviations of inflation not attributable to the listed influences including the estimated effects of changes to tobacco and vaping products duties.

The restrictive stance of monetary policy, both currently and over recent years, is helping to bring inflation back to target. This policy stance has contributed to the economy operating with a margin of spare capacity, which over time weighs on domestic inflationary pressures (Chart 3.2, green bars).

Monetary policy is acting against second-round effects in wage- and price-setting related to the 2022 peak in inflation. To capture these effects, whereby elevated CPI inflation at that time contributed to higher inflation expectations and in turn higher wage growth and inflationary pressures, the MPC introduced a judgement that estimated the extent of these additional effects (Chart 3.2, purple bars), including an assumption that they would unwind more slowly than they emerged (Section 5.3 of the Forecast Evaluation Report – January 2026).

Over the forecast period, the impact of restrictive monetary policy is projected to continue acting against the remaining second-round effects in price- and wage-setting, such that these effects fade and then dissipate by end-2027 (Chart 3.2, purple bars). The margin of slack widens a little further in the near term, which, together with a fall in inflation expectations alongside headline inflation, supports a normalisation in wage-setting. Wage growth is projected to be slightly above its fundamental drivers over much of the first half of the forecast, based on the expected outlook for productivity (Box C), short-term inflation expectations and economic slack (Chart 3.3). The wage growth projection takes some signal from the Agents’ pay survey, which points to wage growth a little above what these fundamentals would imply in 2026 (Section 1.1). Over the second half of the forecast, pay growth is projected to move broadly in line with fundamentals and averages a little under 3%. Wage growth is close to estimated target-consistent levels throughout the forecast (Box A).

Chart 3.3: Wage growth continues to moderate over the forecast

Projections for private sector regular average weekly earnings four-quarter growth ^(a)

• Sources: Bloomberg Finance L.P., Citigroup, ONS, YouGov and Bank calculations.
• (a) The shaded area represents a range of projections from three statistical models of nominal private sector regular average weekly earnings growth, including a wage equation based on Yellen (2017), a wage equation based on Haldane (2018) and a simple error-correction model based on productivity, inflation expectations and slack in the labour market as embodied in the difference between the actual unemployment rate and the estimated medium-term equilibrium rate. The projections are dynamic, multi-step ahead forecasts beginning at a point within the models’ estimation periods and are sensitive to data revisions, which can lead to changes in the range over the past as well as over the forecast period.

Activity

Four-quarter UK GDP growth is projected to strengthen over the forecast period, to around 1.9% by the final year of the forecast. This partly reflects the gradual easing of monetary policy restrictiveness to date, as well as the further easing implied by the market path for interest rates.

The pickup in GDP growth is accounted for primarily by a recovery in annual household consumption growth to a little over 2% by the end of the forecast period. Underpinning this is an expected fall in the saving ratio from just under 10% in 2025 Q4 to around 7½%. Accommodative financial conditions and increasing support from the housing market are also expected to support activity over the forecast period. Housing investment is expected to grow relatively strongly in 2027 and 2028, in part reflecting a positive impact from planning reforms (Section 1 of the May 2025 Monetary Policy Report).

Global growth has been resilient over 2025, and is expected to continue at a steady pace over the forecast. Supportive global financial conditions and a waning impact on growth from tariffs and trade policy uncertainty is expected to support demand for UK exports.

These factors more than offset an increasing drag on demand from fiscal policy over the forecast (Box D). Government spending growth is nonetheless expected to increase somewhat before easing back in 2028.

The degree of slack present in the economy, which is currently estimated to be around 1% of GDP, widens a little further over the course of 2026, before starting to narrow as GDP growth outpaces supply growth (Box C). A small margin of spare capacity is projected to remain at the end of the forecast period. Compared with the November Report, there is a slightly greater degree of spare capacity throughout the forecast period. This in part reflects a judgement to take a signal from recent weaker-than-expected readings on the labour market and on capacity utilisation.

The labour market has continued to loosen as subdued growth in output has fed through to weaker labour demand (Section 1.2). The unemployment rate is projected to peak in the second half of 2026, at around 5¼%, before declining gradually. Unemployment remains above Bank staff’s assumed medium-term equilibrium rate by the end of the forecast period, though there is uncertainty surrounding this estimate (Section 3.2).

3.2: Risks and sensitivities

This section explores the risks to the economic outlook, including the possibility that a higher or lower future path for Bank Rate may be required for inflation to remain at the 2% target sustainably. The section contains an updated assessment of the two scenarios included in the November 2025 Report and sensitivity analysis of the implications for inflation of risks around the current size of the output gap, with the related illustrative policy simulations set out in Annex 2.

Risks around structural change in the economy

There remains a risk that structural changes in the labour market will keep wage growth above target-consistent rates.

Wage growth has continued to moderate over the past year and is expected to fall further as the labour market loosens and headline inflation falls (Section 1). But forward-looking wage indicators including the DMP and Agents’ pay surveys suggest wage growth could remain more elevated. There is a risk that recent years’ large supply shocks have led to lasting changes in wage and price-setting behaviour, resulting in increased real wage resistance and a higher medium-term equilibrium unemployment rate, also known as the non-accelerating inflation rate of unemployment (NAIRU), which in the central projection is expected to be around 4¾% in three years. If the NAIRU is higher, wage growth may fall more slowly than expected in the central projection.

Evidence from clustering analysis of the ways that firms set wages suggests that firms’ wage-setting behaviour has been little changed over recent years (Box B). The analysis also finds that the share of workers whose wages are set in a way that is consistent with collective bargaining-type behaviour appears to be around twice the share of workers who are members of a union. Incorporating this finding into models helps explain why wage growth has typically been higher than expected over recent years and suggests that there is less risk that there has been an unidentified structural change in the labour market.

However, last year’s increase in employer NICs could have resulted in a reduction in effective labour supply (Box F of the November 2025 Monetary Policy Report). The flow of workers leaving payrolled employment has been relatively larger for sectors that are more exposed to the rise in NICs, consistent with a large negative impact on employment in the DMP Survey. There is also a risk that other factors may have led to structural changes in the labour market, including changes in the incidence of long-term sickness, changes in the National Living Wage and developments in public sector wages.

The rate of wage growth that is consistent with inflation at target could be higher or lower depending on the outlook for productivity growth.

The inflation target-consistent rate of wage growth depends on a range of factors including import price inflation, productivity growth and firms’ average margins (Box A). There is uncertainty around how these factors will evolve. In particular, there are risks in both directions around future productivity growth (Box C). On one side, new technology, particularly AI, could boost productivity growth as it is adopted by businesses. In that case, wages could rise more quickly without preventing inflation settling sustainably at the target. On the other side, it is possible that something other than previously identified supply shocks such as the global financial crisis and Brexit has been slowing productivity growth over the past two decades, and that this persists such that the longer-term trend in productivity growth remains weak. All else equal then, wages would need to rise more slowly for inflation to return to target sustainably.

Risks from inflation expectations

Elevated inflation expectations continue to pose a risk that inflationary pressures will remain more persistent, but as inflation is now expected to fall back to around the 2% target in coming months that risk may be receding.

Inflation expectations have remained elevated recently (Section 1.1). And past evidence has highlighted the importance of elevated inflation expectations for wage and price-setting (Box B of the November 2025 Monetary Policy Report).

A scenario in the November 2025 Report explored how past high inflation could continue to affect wage and price-setting in the medium term through inflation expectations. Bank staff have updated that scenario to incorporate data published since then and the new central projection. In this updated scenario, inflation settles above the 2% target under the latest market curve, as it did in the November Report (Annex 2). This is because inflation expectations have remained elevated and could be suggesting additional upward pressure on wages and prices.

The projected fall in inflation in coming months should lead inflation expectations to fall back, which in turn should help lessen the risks highlighted in the scenario. Inflation expectations, particularly for households, tend to move in line with inflation outturns over time. This is particularly likely to be the case as the inflation rate of salient products such as energy and food are expected to fall. In addition, the lower near-term inflation outlook should reduce the risk of threshold effects in inflation dynamics (Box C of the November 2025 Monetary Policy Report). Inflation returning to around the target may therefore lessen the risks incorporated in the scenario.

Nonetheless, developments in inflation expectations are uncertain. Households’ and firms’ recent experience of high inflation may make them less responsive to falling inflation outturns than might be expected based on historical relationships. In this case inflation expectations could remain elevated, as they do in the scenario.

As was the case in the November Report, the set of mechanical policy rules under this scenario generally suggests that Bank Rate would need to be somewhat higher than in the equivalent rules under the central projection (Annex 2). The specific response from those policy rules results from the need to manage a trade-off between persistently above-target inflation and excess spare capacity in the economy. As was the case in November, the MPC would be likely to need to implement an even more restrictive monetary policy response than suggested by these rules to prevent an extended period of above-target inflation. As outlined in Annex 2, each policy rule uses different macroeconomic indicators and weights, leading to a range of different implied future paths for Bank Rate.

Risks from consumption and labour demand

There is a risk that household consumption growth will be slower than anticipated.

The household saving ratio fell by 0.7 percentage points in 2025 Q3, driven by a fall in real household disposable income while real consumption grew modestly. But the saving ratio nevertheless remains above previous averages (Section 1.2). There is a risk that households’ consumption and saving behaviour has changed such that the saving ratio remains elevated, which means consumption could contribute less to demand.

The November 2025 Report explored one potential manifestation of this risk using a scenario calibrated to assume a higher level of household risk aversion, accounting for around one third of the rise in the household saving ratio since 2022. An updated version of this scenario incorporating data developments since November and the new central projection results in inflation falling swiftly and remaining below target throughout the next three years under the market path for interest rates (Annex 2). These results are similar to those shown in the November Report, with the saving ratio staying broadly constant over the next few years rather than declining steadily, consumption growth being slower than in the central projection and the output gap widening by more.

The set of mechanical policy rules under this scenario, with the exception of the forward-looking first-difference rule, suggests that Bank Rate would need to be reduced from its current level (Annex 2). An overall looser stance than implied by the market curve would probably be required to prevent inflation falling persistently below target.

There is a risk that labour demand will be weaker than anticipated and lead to higher unemployment.

Labour demand has remained weak over recent quarters and there is a risk that unemployment continues to rise beyond the near-term peak currently expected. There are some indications that redundancies are rising (Section 1.2). Intelligence from the Bank’s Agents suggests that businesses have grown more cautious about new hiring. And the recent rise in unemployment has been concentrated among the youngest age groups. Employment downturns have historically tended to emerge first among younger cohorts, meaning that these developments could be signalling a greater-than-anticipated weakening in labour demand.

Weaker-than-expected labour demand may have greater consequences for unemployment when the economy is operating on a flat section of the Beveridge curve, as is currently the case. This means that changes to labour demand will tend to be associated with larger movements in unemployment (Box E of the November 2025 Monetary Policy Report). Furthermore, historically there have been relatively few periods in which unemployment has risen slowly. Instead, it tends to be the case that there are turning points where unemployment rises quickly.

Risks around the current level of spare capacity

There is uncertainty over the current level of spare capacity in the economy, which would mean current inflationary pressures are stronger or weaker than embodied in the central projection.

Some of the risks highlighted above would be associated with a different amount of spare capacity in the economy than is currently estimated in the central projection. For example, if there have been structural changes in the labour market such that labour supply is lower than assumed, that would mean that there is less spare capacity in the labour market. In contrast, if potential productivity growth has already been faster as a result of AI technology, there may be more spare capacity in the economy.

There is a range of signals on the level of the output gap from different macroeconomic indicators. Persistently high domestic inflationary pressure and wage growth could be consistent with there being little spare capacity in the economy, but measures of capacity utilisation within firms and rising unemployment suggest that there could be significant spare capacity.

The left panel of Chart 3.4 shows model-based estimates of the current level of the output gap, as well as the output gap in the central projection which synthesises evidence from these models and bottom-up analysis. These models are consistent with current spare capacity in the economy being within a range of around 0.5 percentage points around the central projection of around 1% of potential GDP.

The right panel of Chart 3.4 uses a sensitivity analysis drawing on the relationships underlying the Bank’s COMPASS model to illustrate how uncertainty about the output gap generates uncertainty about the medium-term inflation outlook. If there were 0.5 percentage points more or less spare capacity over the forecast period, then inflation would tend to be around 0.2 percentage points lower or higher each year, holding interest rates in line with the market path of interest rates. These sensitivities are calculated based on a simple change in the output gap and use the model’s Phillips curve estimate, rather than separately modelled changes in components of supply and demand. Nevertheless, the results are similar to alternative estimates based on such changes, for example if there were a different level of the NAIRU.

Chart 3.4: The range of output gap estimates is consistent with differences in the inflation outlook

Output gap estimates, per cent of potential GDP (left panel) and estimated sensitivity of future inflation to a persistent change in the output gap level (right panel) ^(a)

• Sources: ONS and Bank calculations.
• (a) The production function filter is an unobserved components model which integrates a multivariate filter approach with a Cobb-Douglas production function, following Toth (2021). The output gap filter is a dynamic factor model-based estimate of the common cyclical component of GDP (including select GDP expenditure components), labour market indicators, capacity utilisation, wage growth, and inflation, following Jarociński and Lenza (2018). The dynamic factor model is a data driven model that is less reliant on economic assumptions; it is based on 13 cyclical indicators covering labour market tightness, capacity utilisation, wages and inflation.

In the sensitivity with more spare capacity, mechanical policy rules generally suggest that Bank Rate would need to be reduced from its current level and by more so than in the central projection (Chart 3.5, left panel). This is because greater spare capacity also pushes down on inflation.

In contrast, when there is less spare capacity, the policy rules generally suggest Bank Rate would be closer to the market curve used in the central projection, albeit slightly higher (Chart 3.5, right panel). This is because a higher path for Bank Rate would be required to dampen the inflationary pressures generated by the smaller degree of spare capacity.

Chart 3.5: A greater degree of spare capacity would imply a lower path for Bank Rate, while a smaller degree of spare capacity would imply a slightly higher path for Bank Rate, based on mechanical policy rules

Bank Rate levels implied by select monetary policy rules under the central projection and assuming alternative paths for the output gap ^(a)

• Source: Bank of England.
• (a) Annex 2 provides additional detail on the definition of the policy rules shown here and the equivalent paths for the output gap and inflation. These should not be interpreted as a prescription for how policy is likely to evolve.

Risks around the restrictiveness of the monetary policy stance

The degree to which the current monetary policy stance is restrictive is uncertain.

One way to assess whether the current level of Bank Rate is restrictive is to compare it to an estimate of the neutral rate. The neutral rate, or equilibrium real interest rate, can be defined as the time-varying real interest rate that, if the economy started from a position of no output gap and inflation at target, would sustain output at potential and inflation at target. Overall, the evidence suggests that current monetary policy remains somewhat restrictive but, as Bank Rate has been reduced over recent quarters towards the neutral rate, it is becoming harder to judge exactly the extent of restrictiveness where small numbers are involved. Meanwhile, past higher levels of Bank Rate are continuing to reduce demand in the economy because of lags in transmission (Section 3.1).

Updated Bank staff models of the gap between Bank Rate and the neutral rate (Box A of the August 2025 Monetary Policy Report) suggest that there is currently a small positive real interest rate gap, ranging from around 0–1 percentage point (Chart 3.6, aqua and orange bars). That accords broadly with evidence from macroeconomic indicators of the monetary policy transmission mechanism (Box E).

Chart 3.6: Models generally suggest that the current stance of monetary policy remains restrictive, although this is uncertain

Average real interest rate gaps in February 2026 ^(a)

• Sources: Bank of England, Bank of England/Ipsos Inflation Attitudes Survey, Bank of England Market Participants Survey (MaPS), Bloomberg Finance L.P., Consensus Economics, Davis et al (2024), DMP Survey, ONS, TradeWeb FTSE Gilt Closing Data and Bank calculations.
• (a) All measures of the real interest rate gap presented in this chart show the implied degree of monetary policy restrictiveness over a three-year horizon. The macroeconomic models range is produced using estimates from a dynamic semi-structural investment-saving curve model and one of the main models underlying the central projection in this Report (Albuquerque et al (2025)). The macrofinancial model range is estimated using the state-space model from Davis et al (2024), with a 95% confidence interval applied around the central estimates of the neutral rate. The financial markets range uses estimates of the nominal neutral rate derived from five term-premia models: the benchmark and survey models in Malik and Meldrum (2016), Vlieghe (2016), Andreasen and Meldrum (2015) and Meldrum and Roberts-Sklar (2015). These estimates are adjusted by average six-year to 10-year inflation expectations from half-year Consensus surveys to obtain real neutral rate estimates. The real policy rates in the financial markets ranges are calculated as the average instantaneous forward OIS curves over three-year horizons, deflated by annual Consensus survey inflation expectations over this period. These inflation expectations are linearly interpolated over the three-year horizon. The instantaneous forward OIS curves are estimated using the average paths for interest rates in the 15 UK working days to 26 January 2026, on which the baseline projections for the February Report are conditioned. The DMP range is based on the difference between DMP respondents’ nominal one year ahead Bank Rate expectation relative to their three-year ahead Bank Rate expectation (which is assumed to match their perception of the neutral rate), adjusted by their expectation for CPI inflation over the same periods. The range shows the 10th–90th percentile of perceptions and the data were collected between November 2025 and January 2026.

Some alternative indicators suggest that monetary policy may no longer be restrictive. Financial market derived measures of the real interest rate gap, MaPS and the DMP Survey all provide a wide range of estimates of the real rate gap (Chart 3.6). These ranges are wide enough that it is possible that Bank Rate may be around neutral or slightly accommodative, although these results are sensitive to the definition of inflation expectations used, and financial market contacts generally consider the current level of Bank Rate to be restrictive.

Global shocks

Global risks remain elevated.

One area of continued uncertainty has been around global trade policy. Bank staff analysis suggests that the impacts of past increases in US tariffs, and the associated trade policy uncertainty, on global GDP have so far been smaller than expected. There remains a risk that the US government raises some tariff rates further in the future. And there are risks that heightened trade policy uncertainty has larger effects on the UK and global economy, for example by depressing businesses’ investment and via financial markets. Longer-term impacts on global productivity growth from greater global trade restrictions may also be larger, for example through less efficient allocation of activity.

There is also uncertainty over the extent to which trade policy changes are affecting global export prices and to what extent this is reflected in UK import prices. There is indicative evidence that US tariffs have led to slower growth in export prices among countries more exposed to the new tariffs, particularly China since March 2025 (Garofalo and Prayer (2026)). This could be consistent with these countries facing reduced demand for their exports. UK import prices moved broadly in line with global export prices over 2025. If tariffs continue to slow global export price growth, that could reduce inflationary pressure in the UK, although the magnitude of this effect remains uncertain. Geopolitical developments also continue to create substantial uncertainty around the outlook for energy prices.

Optimism about AI technology has boosted financial markets in recent years. If the benefits of this technology are lower than expected, this could reduce UK GDP.

New AI technologies have increased global GDP growth, with the US particularly affected. This has been through increased investment, and by raising financial market asset prices. If the productivity and commercial benefits of AI technology are smaller than expected, that is likely to result in lower global investment, reducing global GDP. As the UK is not a main exporter of AI-related equipment, the UK impact should be limited. The UK economy would be more exposed through the effect on equity prices. If US stock markets fall after a reassessment of the value of AI, that would be likely to spillover into a fall in UK equity prices, with potential knock-on effects on other financial assets. That would lower the value of assets held by UK households and businesses, reducing consumption and investment. Given the fact that AI investment has been financed predominantly through cash and equity to date, the FPC considers that that currently limits the likelihood of severe systemic risk implications from a market revaluation of the benefits of AI (Box C of the December 2025 Financial Stability Report). In general, to the extent that tail risk type events do not significantly affect the current balance of risks in the economy, it is unlikely to be effective for monetary policy to respond pre-emptively, particularly if the probability or impact of the shock occurring is unaffected by the monetary policy stance.

Annexes

Glossary and other information