Monetary Policy Report - May 2025

1: The economic outlook

1.1: The conditioning assumptions underlying the MPC’s baseline projections

As set out in Table 1.B, the MPC’s May baseline projections are conditioned on:

• The paths for policy rates in advanced economies implied by financial markets, as captured in the 15 working day averages of forward interest rates to 29 April (Chart 2.3). The market-implied path for Bank Rate underpinning the May projections declines to just over 3½% by the middle of the forecast period, around ½ percentage point lower on average than in the February Report.
• A path for the sterling effective exchange rate index that is around 2% higher compared with the February Report. The exchange rate depreciates slightly over the forecast period, reflecting the role of expected interest rate differentials in the Committee’s conditioning assumption.
• Wholesale energy prices that follow their respective futures curves over the forecast period. Since February, oil and gas prices have fallen (Chart 2.4). Significant uncertainty remains around the outlook for wholesale energy prices.
• UK household energy prices that move in line with Bank staff estimates of the Ofgem price cap implied by the paths of wholesale gas and electricity prices (Section 2.5).
• UK fiscal policy that evolves in line with government policies to date, as announced in Spring Statement 2025 (Section 2.3).
• Global and UK trade policies as of 29 April including a continuation throughout the forecast period of the current very high US-China bilateral tariffs and of the current 90-day pause on higher-band US tariffs excluding China (Box C).

1.2: Key judgements and risks

1.2: Key judgement 1

Progress on disinflation in domestic price and wage pressures is generally continuing. While headline inflation is expected to rise in the near term to 3.5%, the MPC judges that this will not lead to additional second-round effects on underlying domestic inflationary pressures.

Twelve-month CPI inflation peaked at around 11% at the end of 2022, following the succession of very large external cost shocks that occurred in 2021–22. Inflation fell back in 2023 and progress on disinflation has continued since then. This has allowed the MPC to reduce gradually the degree of monetary policy restrictiveness.

CPI inflation was 2.6% in March and averaged 2.8% in 2025 Q1, above the MPC’s 2% target but close to expectations at the time of the February Report (Section 2.5). CPI inflation excluding energy has remained around 3½% over recent quarters, compared with its peak of nearly 8½% in mid-2023 (Chart 1.1).

The latest evidence suggests progress on disinflation in domestic price and wage pressures is generally continuing, supported by the restrictive stance of monetary policy.

Services consumer price inflation has risen over recent months, to 4.7% in March from 4.4% in December, but to a slightly lesser degree than expected at the time of the February Report. This increase in services inflation and a further rise expected in April relate partly to volatility in airfares, while there is also upward pressure from increases in regulated and administered prices. Measures of underlying services price inflation have continued to ease gradually since their peaks in 2023 but remain elevated (Chart 2.24).

After having risen in 2024 H2, annual private sector regular average weekly earnings (AWE) growth declined to 5.9% in the three months to February, weaker than expected in the February Report. Most other measures of pay growth have also fallen back somewhat over recent months (Chart 2.16). Private sector regular pay growth is expected to slow significantly further by the end of 2025, to around 3¾%, consistent with the latest indications from Agency intelligence and the DMP Survey.

The MPC monitors a range of indicators from households, businesses and financial markets to make a joint assessment of whether inflation expectations remain consistent with meeting the 2% inflation target sustainably in the medium term. Having fallen significantly from the end of 2022, survey measures of household inflation expectations have risen since mid-2024 (Chart 2.26). These increases have been towards the top of the band of, or a little above, what would be implied by the rise in CPI inflation over the past year, suggesting that households’ inflation expectations may have become more responsive to inflationary pressures since the period of very high inflation in 2022. Businesses’ medium-term CPI inflation expectations have increased slightly recently, although indicators of medium-term inflation expectations derived from financial markets have generally continued to trend downwards. Monetary policy will act to ensure that longer-term inflation expectations are anchored at the 2% target.

In the May Report projection, CPI inflation is expected to rise in coming months, to 3.4% in 2025 Q2 and to a peak of 3.5% on average in Q3, in large part reflecting developments in household energy bills and, to a lesser degree, regulated prices (Chart 2.20). Although wholesale energy prices have fallen back since the February Report, the direct energy price contribution to 12-month CPI inflation is projected to increase from ‑0.5 percentage points in 2025 Q1 to around zero in Q2 and Q3 (Chart 1.1). That pickup in large part reflects the announced increase in the Ofgem energy price cap in April, and that the large fall in the price cap last April will drop out of the annual comparison.

The projected increase in CPI inflation over coming months is still expected to be temporary. This in part reflects the Committee’s judgement that the near-term increase will not lead to additional second-round effects on underlying domestic inflationary pressures, beyond those that would typically be expected to occur and in contrast to the more persistent dynamics in the inflation generating process that occurred following the very large shocks in 2021–22. This reflects that there is going to be a much smaller increase in headline inflation than at that time and comes against the backdrop of a looser labour market.

In this forecast, the Committee has also maintained its judgement on the speed with which overall excess domestic inflationary pressures are expected to dissipate in the medium term (Key judgement 3). There is elevated uncertainty around this judgement, in part related to global trade developments since the February Report. In assessing the medium-term outlook for CPI inflation, the MPC is considering a wide range of risks alongside its baseline forecast.

As set out in Box A, Bank staff have constructed two alternative scenarios for how the economy may evolve. These demonstrate the mechanisms through which: first, there could be greater or longer-lasting weakness in demand relative to supply, in part reflecting uncertainties globally and domestically, which would lead second-round effects to fade more quickly; or second, there could be more persistence in domestic wage and prices, both from additional second-round effects related to the near-term increase in CPI inflation and from weaker supply. These scenarios are designed to represent plausible rather than tail outcomes. So, for example, they would generally sit within the central bands of the fan charts published in this Report, even though they are not technically drawn from the distributions of the fan charts. Such a comparison does not imply anything about the precise likelihood of the scenarios occurring.

The scenarios described in Box A are merely two examples from a wide range of different paths that the UK economy could take. Broader global risks are discussed in Key judgement 4, including those related to the unpredictability of future trade policies. Key judgement 2 discusses other risks to the balance of demand and supply, and hence to underlying inflationary pressures.

1.2: Key judgement 2

A small margin of excess supply has opened up in the UK economy. This is expected to widen over the next couple of years, to just under 1% of potential GDP, before narrowing by the end of the forecast period.

Underlying UK GDP growth is judged to have slowed since the middle of 2024 and has been much less volatile than growth in headline GDP (Section 2.3). Underlying GDP growth is expected to have been around zero in 2025 Q1, well below Bank staff’s projection for headline growth of 0.6%. The S&P Global UK composite output PMI fell sharply in April, suggesting downside risks around the near-term outlook. Household spending growth has remained subdued over recent quarters, although real incomes have risen quite strongly such that the saving ratio increased to 11.6% in 2024 Q4, its highest level since the pandemic.

Underlying employment growth has also softened recently and the labour market has continued to loosen (Section 2.4). The ratio of vacancies to unemployment has fallen further and is now judged to be below its equilibrium level. The impact of higher NICs on employment appears to have been fairly small to date.

As outlined in Box E of the February Report, much of the recent weakness in productivity growth is judged to reflect weaker growth in potential productivity. Potential productivity remains notably weaker than can be explained by previously identified factors such as the impacts of past shocks from Brexit and the pandemic.

Overall, a small margin of excess supply is judged to have opened up around the turn of last year. This is consistent with labour market developments, survey indicators of capacity utilisation and top-down statistical estimates of the output gap. The MPC continues to recognise the significant uncertainty around estimates of slack in the economy.

The outlook for UK activity will be determined by both domestic and global factors.

As set out in Box C, current global trade policy developments are likely to reduce UK GDP growth. Weaker UK-weighted world GDP growth is expected to weigh on demand for UK exports, which in turn drags on UK growth. And some degree of expenditure switching by US consumers away from imports, including those from the UK, and towards domestically produced products, further weighs on UK growth. Trade-related developments in financial markets have generally pushed down on growth, including the appreciation of the sterling exchange rate, although these effects are partly offset by the fall in short-term interest rates since February.

The MPC judges that the current stance of monetary policy remains restrictive. Under the latest market-implied path for interest rates, including its expected impact on broader financial conditions, monetary policy is expected to have a broadly neutral impact on GDP growth over much of the forecast period, even as its previous negative impact on the level of GDP remains. There remain uncertainties around the impact of monetary policy on demand and hence on the margin of slack in the economy.

The measures announced in Spring Statement 2025 are expected to have little impact on the UK’s fiscal stance, and hence on projected GDP growth, over the three-year forecast period. The overall stance of fiscal policy is still expected to tighten. This pulls down somewhat on the GDP growth projection over most of the forecast period beyond the next few quarters.

In the May forecast, four-quarter GDP growth is projected to remain close to its current level, of just over 1%, before picking up towards the end of the forecast period (Chart 1.2). Quarterly growth rates are expected to be slightly weaker than in the February Report at the start of the forecast beyond 2025 Q1 and slightly stronger further out.

Household spending growth is projected to pick up throughout most of the forecast period (Table 1.D), supported by a declining saving ratio that in turn reflects the impact of the downward-sloping assumed path of interest rates. Annual housing investment growth is expected to strengthen to 5% in 2026 and to 6% in 2027, in part reflecting a positive impact from planning reforms over time. Business investment growth is weak throughout much of the forecast period. Export growth has been revised down, particularly in 2026, compared with the February Report, owing to global trade developments. Trade data have been volatile recently, which may make it harder to assess underlying developments going forward.

Four-quarter potential supply growth is projected to remain at around 1½% in the medium term. Within that, potential labour supply growth is around ¾% per annum in the medium term. Potential productivity is assumed to recover some of its recent weakness and settles at annual growth rates of around ¾%.

Reflecting these paths of GDP and potential supply, the margin of excess supply is expected to widen further over the next couple of years in the May forecast, from ¼% in 2025 Q1 to just under 1% of potential GDP by the end of 2026. That in large part reflects the tightening in the stance of fiscal policy and the continuing restrictive stance of monetary policy. The margin of slack is then projected to narrow by the end of the forecast period. Relative to the February Report projection, there is expected to be a slightly greater margin of excess supply throughout most of the forecast period, in part reflecting global trade developments.

The unemployment rate is projected to rise gradually to around 5% by the end of 2026 (Chart 1.3), above its assumed medium-term equilibrium rate of just over 4½%. Unemployment is somewhat higher than in the February Report, in part reflecting a slightly higher starting point suggested by the current LFS data.

There are considerable risks around the future path of excess supply in the economy, and hence inflationary pressures in the medium term, reflecting both global (Key judgement 4) and domestic factors.

As set out in Box A, Bank staff have prepared an alternative scenario in which aggregate demand is substantially weaker than in the baseline projection, as an additional UK-specific increase in uncertainty drags on consumption and investment to a greater extent. There may also be other downside risks to demand from recent consumption and saving behaviour. The Committee has for some time expected the household saving ratio to decline and support consumption over the forecast period, but saving has so far continued to increase and to a greater degree recently than can be explained by the stance of monetary policy.

Supply growth could be weaker than in the baseline forecast if potential productivity were to recover less from its recent unexplained weakness. In this case, the implications for GDP growth and slack in the economy would depend on the speed with which weaker supply fed through into weaker demand. Box A sets out an alternative scenario in which potential productivity growth is materially weaker than in the baseline, and that weakness in productivity is not reflected in lower wages, which adds to domestic inflationary pressures.

Overall, the Committee judges that the risks around GDP growth in this forecast are somewhat to the downside. On balance, this is also judged to lead to a risk of a greater margin of excess supply over the forecast period than in the baseline.

1.2: Key judgement 3

Conditioned on the market path of interest rates, the building margin of excess supply in the economy acts against some continuing second-round effects in domestic prices and wages in order for CPI inflation to fall back to around the 2% target in the medium term.

As for the growth outlook, medium-term inflationary pressures are being affected by both domestic and global factors.

As set out in Box C, and conditional on current global trade policies and asset prices, the evidence to date suggests that the overall impact of trade developments on the UK is more likely to be disinflationary than inflationary. Consistent with this, the effects incorporated into the baseline forecast are negative, though not large particularly in the medium term.

UK non-energy import prices are projected to be 2¼% lower than expected at the time of the February Report over the forecast period. That in part reflects the assumed effects of reduced US import demand in response to higher tariffs (Key judgement 4). The recent appreciation in sterling also weighs on UK import prices over the forecast period, which drags further on inflation. The degree and timing of pass-through from import prices to CPI inflation will be affected by the domestic costs of transport and retailing.

Overall, there is significant uncertainty around the size, and possibly the sign, of any net effect on UK inflation of trade developments. The risks to global inflation set out in Key judgement 4 apply to the UK. For example, there is uncertainty around the extent of the shift in global trade patterns and developments in major economies’ exchange rates, and how these may come to affect the UK in particular. The UK pricing decisions of multinational corporations could be affected indirectly by their exposure to higher costs in other jurisdictions.

Domestically, the May forecast for CPI inflation continues to incorporate a period of economic slack, which is required in order for pay and price-setting dynamics to normalise fully. The Committee has not changed its judgement on the speed with which excess domestic inflationary pressures are expected to dissipate. The continuing second-round effects in this forecast relate in large part to the unwind of the succession of very large external cost shocks in 2021–22, rather than additional second-round effects from the near-term pickup in headline inflation (Key judgement 1).

In the projection conditioned on the market-implied path of interest rates in the 15 working days to 29 April, CPI inflation falls back gradually from 3.5% in 2025 Q3 to around the 2% target in the medium term (Chart 1.4 and Table 1.C). This reflects the continuing restrictive stance of monetary policy and the building margin of slack in the economy.

The May CPI projection is broadly similar to the profile in February throughout the forecast period, albeit slightly lower. In the medium term, that reflects the downward pressure on inflation from a slightly wider margin of slack throughout most of the forecast period and the weaker contribution from import price pass-through, in turn owing to the impact of global trade developments and the appreciation of the sterling exchange rate.

Private sector regular AWE growth is expected to fall from around 3¾% at the end of this year to just under 3% in the medium term, similar to the February Report (Table 1.D).

There remains uncertainty around the calibration of the Committee’s judgement on the path of second-round effects in domestic prices and wages. The staff scenarios in Box A describe two alternative paths for the persistence of inflationary pressures.

In the first scenario, economic slack builds and inflation persistence fades more quickly than in the baseline projection, including via a temporary steepening in the slope of the Phillips curve.

The second scenario explores the possibility that inflation persistence is greater than assumed in the baseline, including that the upcoming rise in headline inflation results in additional second-round effects in domestic wage and price-setting alongside weaker supply.

These scenarios do not encompass all the risks around inflationary pressures in the medium term. For example, there remains a risk that the economy has been subject to lasting changes in wage and price-setting behaviour following the major supply shocks experienced over previous years. The path for the medium-term equilibrium rate of unemployment could be higher than has been assumed in the forecast, which would be consistent with greater persistence in wage growth.

Overall, the Committee judges that the risks around the CPI projection are two-sided. Downside risks to growth, which carry through to inflation, are offset broadly by upside risks from the persistence of domestic inflationary pressures.

1.2: Key judgement 4

New tariff announcements and the elevated level of trade policy uncertainty weigh on global activity. World export prices are expected to be materially weaker, particularly in China.

The world economy has been subject to several new shocks over recent months, including the imposition of significant changes in tariffs by the United States and some of its trading partners, the associated and intensifying trade policy uncertainty, and the prospective loosening in euro-area fiscal policy. What matters for UK monetary policy is the overall impact of these developments on the outlook for CPI inflation in the medium term (Key judgement 3), and how the risks around the constellation and impact of global trade policies would affect UK inflationary pressures if they were to transpire.

There has been significant volatility and movements in financial markets since the February Report, with partly offsetting effects on financial conditions (Section 2.1). Global equity prices have fallen, market-implied policy rates are lower, and the US dollar has depreciated, as market participants have reassessed the impact of, and uncertainty around, tariffs and broader economic policies on the global outlook.

Global trade policy uncertainty rose sharply after the US presidential election and has risen further since the February Report, to its highest recorded level (Chart B in Box C). This is likely to weigh on world growth by causing households and businesses to delay spending decisions. The Committee has allowed for these global effects to pull down on its UK growth forecast, but has not incorporated an additional UK-specific increase in uncertainty in its baseline projection beyond the effects already apparent in business surveys. The May forecast assumes that global trade policy uncertainty remains at a very elevated level in the near term before falling back, though at a slower pace than in previous episodes of heightened economic uncertainty.

In the baseline forecast, and conditioned on current trade policies, tariffs directly increase the price of imported goods in the US and reduce demand for tradeable goods in the rest of the world. Tariffs are expected to weaken potential supply in the countries that initiate them as production shifts to less efficient inputs, firms and sectors. The global economy adjusts through a mix of reduced prices and quantities, including via reduced US demand and shifts in global trade patterns.

German fiscal policy is assumed to be loosened significantly following policy changes including the exemption of defence spending above 1% of GDP from the debt brake, and the creation of a €500 billion deficit-financed infrastructure fund. Some other euro-area countries are also assumed to increase defence spending to a smaller degree.

Overall, the level of global GDP is now expected to be around ¾% weaker over the forecast period than in the February Report, as new tariff announcements and the elevated level of trade policy uncertainty weigh by more than the prospective boost from looser euro-area fiscal policy. Four-quarter UK-weighted world GDP growth falls back to around 1½% this year and next, before rising to just over 2% in 2027.

Conditioned on current trade policies and the profile of trade policy uncertainty, growth is projected to weaken most significantly in the United States and in China, with a peak negative impact on the level of GDP of around 1¾% and 2% respectively compared with the February Report. The majority of this weakness is matched by lower potential output owing to the assumed impacts of tariffs. Fiscal policy is assumed to provide a partial offset to the trade impacts in China.

Euro-area GDP is also weaker overall throughout much of the forecast period due to the impact of tariffs and trade policy uncertainty. This is despite the assumed loosening in German and, to a lesser degree, other countries’ fiscal policy, which boosts euro-area GDP over time by just over ½% by the end of the forecast period relative to the February Report.

An important part of the adjustment to higher tariffs comes through lower world export prices rather than lower export volumes. In this forecast, four-quarter UK-weighted world export prices, excluding the direct effect of oil prices, are expected to be around 2% lower than in the February Report, reflecting lower energy prices as well as the estimated effects of changes in global trade patterns. In particular, Chinese export prices are projected to be over 10% lower than in February by the end of the forecast period, owing to reduced US demand. Headline consumer price inflation across advanced economies is expected to diverge, primarily due to tariff impacts, with US inflation rising but euro-area inflation falling over coming quarters.

The global outlook is highly uncertain and the balance of risks around that outlook is very difficult to judge. The future constellation of trade policies is impossible to predict at this juncture, and the impact of a given set of trade policies on world growth and inflation is hard to estimate with precision. There is also uncertainty about the response of global financial markets to future trade developments, including exchange rates. These uncertainties also apply to the outlook for UK growth and inflation (Key judgements 2 and 3).

In terms of its impact on the baseline forecast, any future news on trade policy can be judged relative to the conditioning assumption of a continuation of the current very high US-China bilateral tariffs and of the current 90-day pause on higher-band US tariffs excluding China. Negotiated solutions may weaken the assumed tariff shock, while broader global trade fragmentation could result in a stronger shock.

There is particular uncertainty about the scale of export price adjustment in China given the very large and persistent shock to trading patterns that has been assumed in the forecast. The degree of price response could be stronger or weaker than expected.

This forecast assumes that current trade developments do not lead to significant global supply chain disruption, such as through geoeconomic fragmentation or the rewiring of shipping routes. Supply chains could be disrupted more materially and quite quickly if fragmentation or the need to exclude certain supply sources result as economies impose new tariffs and non-trade barriers, pushing up on world export prices and weighing on global activity. As global resources are reallocated away from the most efficient allocation based on comparative advantage, tariffs could also lead to weaker global productivity growth, beyond the US and China.

As set out in the April 2025 FPC Record, several risks associated with the fragmentation of global trade in goods, and financial markets, have intensified. A major shift in the nature and predictability of global trading arrangements could harm financial stability by depressing growth. A further risk is a reduction in global co-operation, which could reduce resilience. The FPC will continue to monitor the situation closely and will provide an update on these risks at the time of its July Financial Stability Report.

There are also uncertainties around the paths of fiscal policy in Germany and elsewhere. For example, more extensive European defence spending than assumed in the forecast would present an upside risk to global activity and world export prices.

2: Current economic conditions

Chart 2.1: In the MPC’s latest projections, headline GDP growth rises in 2025 Q1 while underlying GDP growth remains weak, the unemployment rate edges higher, and CPI inflation picks up from 2025 Q2

Near-term projections ^(a)

• Sources: BCC, CBI, Lloyds Business Barometer, ONS, S&P Global and Bank calculations.
• (a) The lighter diamonds show Bank staff’s projections at the time of the February Report. The darker diamonds show Bank staff’s current projections. The azure diamonds in the top panel are Bank staff’s estimates of underlying quarterly GDP growth. Underlying GDP data from 2023 Q2 to 2024 Q4 show in-sample fitted values of a survey indicator model estimated by Bank staff, and data for 2025 Q1 and 2025 Q2 show out of sample projections (see Chart 2.8). The projections for headline GDP growth and the unemployment rate are quarterly and show 2025 Q1 and 2025 Q2 (February projections show 2024 Q4 to 2025 Q2). The projections for CPI inflation are monthly and show April to September 2025 (February projections show January 2025 to June 2025). The GDP growth and unemployment rate projections for 2025 Q1 are based on official data to February 2025, while the CPI inflation figures over the same quarter are outturns. 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 very low response rates, which can introduce volatility and potentially non-response bias (Box D of the May 2024 Monetary Policy Report).

2.1: Global economy and financial markets

There have been significant geopolitical developments since the February Report.

Since the February Report, new tariffs have been implemented by the US, some countries have retaliated, and trade policy uncertainty has risen further (Box C). The German Parliament has passed significant fiscal reforms, including the exemption of defence spending above 1% of GDP from the debt brake, and the creation of a €500 billion deficit-financed infrastructure fund. Meanwhile, there have been negotiations around a ceasefire in the war in Ukraine.

Financial markets have been volatile in response to this geopolitical news.

Since the February Report, financial market participants have reassessed the expected impact of trade and broader US economic policies on the global growth outlook. Implied volatility has risen for many asset prices, with the Chicago Board Options Exchange’s VIX measure of equity market implied volatility peaking at its highest level since 2020 in April, partly reflecting the continued rise in trade policy uncertainty.

Global equity prices fell sharply following news that tariffs in excess of 10% would be placed on most of the United States’ biggest trading partners, before recovering somewhat following a 90-day pause to these measures for all countries except China (Box C). In the 15 UK working days to 29 April 2025, the S&P 500 index was on average 7% below its pre-US election level (Chart 2.2, left panel). US equity prices have risen since then and were 2% lower than their pre-US election level on 2 May. US equity market valuations remain elevated in an absolute sense (April 2025 FPC Record). In the 15 UK working days to 29 April 2025, European equity prices had also fallen slightly relative to their level in the February Report, despite the strong performance of European defence stocks following the announcement of recent German fiscal reforms. But since the 15-day average window, the Euro Stoxx index has risen to above its level in the February Report.

Investment-grade corporate bond spreads have widened across advanced economies but remain tight relative to their peaks in March 2020. In the 15 UK working days to 29 April, the US dollar effective exchange rate had fallen to 3% below its level ahead of the US election (Chart 2.2, middle panel). Exchange rates have been volatile in response to the trade policy announcements from the US and other countries.

UK risky asset prices have also responded to global news. In the 15 UK working days to 29 April, the FTSE All-Share index had fallen by 3% relative to its level in the February Report, having been as much as 10% lower in the days following the US tariff announcements on 2 April. UK equity prices have risen since then, and the FTSE All-share index was around 2% above its level in the February Report on 2 May. Sterling investment-grade corporate bond spreads had widened by around 30 basis points since the February Report, broadly in line with moves in equivalent spreads in the US. The sterling effective exchange rate had appreciated by around 2%, primarily reflecting US dollar weakness, although sterling had depreciated by around 2% against the euro.

There have been some quite sharp movements in government bond markets in the past three months. In the 15 UK working days to 29 April, 10-year UK gilt and US treasury yields were 10 basis points and 30 basis points lower, respectively, than in the February Report (Chart 2.2, right panel). Those moves reflect lower interest rate expectations, which have been partly offset by rises in term premia, the additional compensation investors require to hold a longer-term bond relative to a series of shorter-term bonds. Thirty-year UK gilt yields have been more volatile and have broadly tracked moves in long-dated US treasury yields. Market intelligence suggests that lower liquidity in long-dated bonds has exacerbated these moves. Longer-term euro-area government bond yields are little changed overall, as anticipation of higher deficit-financed defence spending has provided a counterbalance to the impact of trade policy news.

Chart 2.2: Global equity prices fell sharply in response to US tariff announcements, the US dollar has depreciated to below its pre-US election level and 10-year government bond yields are little changed overall since the February Report

Changes in equity indices, effective exchange rates and 10-year government bond yields since 5 November 2024 ^(a)

• Sources: Bloomberg Finance L.P., Tradeweb FTSE Gilt Closing Data and Bank calculations.
• (a) Equities and effective exchange rates are indexed to the date of the 2024 US presidential election, while 10-year yields show cumulative changes in yields over the same period. The final data points are for 29 April 2025.

The market-implied paths for advanced economy policy rates have fallen since the February Report, particularly in the US.

The European Central Bank (ECB) Governing Council cut its deposit facility rate to 2.25% at its April meeting. Meanwhile, the Federal Reserve’s Federal Open Market Committee maintained the target range for the federal funds rate at 4.25%–4.5% at its March meeting, while announcing a slower pace for its quantitative tightening programme.

The market-implied path for US policy rates has fallen significantly since the February Report, as markets have reassessed the implications of trade and other economic policies on the outlook for US economic growth and inflation (Chart 2.3). The market-implied path for the ECB’s deposit facility rate is also lower than in the February Report, particularly in the near term. Some market contacts expect that the negative effect of trade tariffs on economic growth will more than offset the near-term boost to activity from higher defence and infrastructural spending in Germany and other European countries.

Based on the 15-day averages to 29 April 2025, 85 basis points and 65 basis points of cuts were priced into the US and euro-area curves, respectively, over the remainder of this year. For the euro area, this implied a total reduction of 140 basis points over 2025. The effective federal funds rate was expected to stand at 3.5% in three years’ time, around 60 basis points lower than in the February Report. The market-implied path for euro-area rates sloped gently upwards from 2026, to 2.1% in three years’ time, around 15 basis points lower than in the February Report.

The market-implied path for the UK policy rate has fallen since the February Report but as of the 15-day average to 29 April 2025, movements had been smaller than those for the US. Based on this 15-day average, Bank Rate was expected to stand at 3.6% by the end of 2025, before rising slightly to 3.7% by the end of the forecast period. That was around 30 basis points lower than in the February Report. Since 29 April, the market-implied path for Bank Rate has fallen further. On 2 May, Bank Rate was expected to stand at 3.6% in three years’ time.

Chart 2.3: The market-implied path for US policy rates has shifted notably lower since the February Report, while the UK and euro-area paths have also fallen

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 29 April 2025. The February 2025 curves are estimated based on the 15 UK working days to 28 January 2025. The May 2025 curves are estimated using the 15 UK working days to 29 April 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 June 2028.

The large moves in asset prices since the February Report have had opposing effects on financial conditions.

Despite large moves in some UK and global asset prices, financial conditions, taken together, were estimated to be broadly unchanged between the February Report and the 15 UK working days to 29 April. Lower equity prices and an appreciation in the sterling effective exchange rate had caused a tightening in financial conditions relative to the time of the February Report. But reductions in medium-term market-implied interest rates had acted in the opposite direction.

Key commodity prices have fallen since the February Report and the effects of increased trade tariffs are expected to lead to weaker world export price inflation.

Since the February Report, spot Brent crude oil prices have fallen and oil futures prices have also shifted lower (Chart 2.4). In the 15 UK working days to 29 April, spot prices had fallen by around 15% to $67 per barrel. And by 2 May, prices had fallen to $62 per barrel. Concerns that a weaker global economic growth outlook will result in lower oil demand have been the primary driver of these moves, while increased production by OPEC+ countries since April has also weighed on prices. Natural gas prices have fallen since the February Report in response to trade policy developments, and the futures curve is now a little below its November 2024 level. Market intelligence suggests that ceasefire negotiations between Russia and Ukraine and increased European imports of liquified natural gas have contributed towards the fall in gas prices. All else equal, recent reductions in wholesale energy prices are expected to weigh on UK CPI inflation this year, relative to expectations at the time of the February Report (Section 2.5).

Increases in global trade barriers are expected to weigh on global export price inflation over coming quarters, in part due to lower US demand for imports (Box C, and Box C of the February 2025 Monetary Policy Report). Some agricultural commodity prices have moved a little lower since the February Report, following the imposition of tariffs on imports of some agricultural goods. And other non-oil goods export prices are expected to fall over coming quarters, as rises in tariffs reduce US demand for imports (Section 1.2). Overall, global non-oil export prices are expected to fall by 0.7% over 2025 H2, compared with a 0.2% rise at the time of the February Report. Changes in global export price inflation tend to feed through to changes in UK consumer price inflation with a lag (Box D of the November 2024 Monetary Policy Report).

Chart 2.4: Natural gas and crude oil futures prices have fallen since the February Report

UK wholesale natural gas and oil spot and futures prices ^(a)

• Sources: Bloomberg Finance L.P. and Bank calculations.
• (a) Spot prices are monthly averages of Brent crude oil and Bloomberg UK NBP Natural Gas Forward Day prices respectively. Natural gas prices are in sterling while oil prices are in US dollars. The dashed lines refer to respective futures curves using one-month forward prices based on the 15-day averages to 29 April 2025, while dotted lines are based on the 15-day averages to 28 January 2025. The final data points shown are forward prices for June 2028.

World trade growth has remained robust since the US presidential election, although some of this strength may reflect front-loading of imports.

Data on world trade are only available for the period prior to the 2 April tariff announcements. They suggest that since the US presidential election, measures of global goods trade growth have been robust. The World Trade Organization’s Goods Trade Barometer indicates that global goods trade growth increased in January 2025, and had been particularly strong in components such as container shipping and automotive products. But qualitative responses to recent S&P Global PMI surveys suggest that some of this strength may have been driven by temporary front-loading of imports by businesses, given growing trade policy uncertainty and the anticipation of additional tariff measures.

Global trade policy developments are expected to weigh significantly on near-term world activity.

Quarterly UK-weighted world GDP growth is projected to have slowed to 0.4% in 2025 Q1 (Chart 2.5), in line with the projection in the February Report. Global activity growth is projected to slow further to 0.3% in 2025 Q2, slightly weaker than expected in February, and then to 0.2% in 2025 Q3, as the impact of higher trade barriers and trade policy uncertainty weigh on world growth.

According to the advance estimate, US GDP contracted by 0.1% in 2025 Q1, much weaker than the growth of 0.5% projected at the time of the February Report. That slowdown partly reflected a large increase in imports, ahead of the implementation of higher tariffs. Other US activity indicators have generally softened over recent months, while forward-looking consumer and business confidence survey measures have deteriorated. Much of the weakness in these measures appears to have been driven by the impact of implemented and announced trade policies, and broader US economic and trade policy uncertainty. Bank staff project that US activity growth will remain weak in the near term, with quarterly GDP growth expected to average 0.1% over the remainder of 2025. Near-term risks to US activity growth are judged to be skewed to the downside, partly owing to the potential for severe supply chain disruptions from existing tariff measures (Box C).

According to the preliminary flash release, euro-area activity growth picked up to 0.4% in 2025 Q1, higher than expected in the February Report, following growth of 0.2% in 2024 Q4. Bank staff project that euro-area GDP growth will slow to 0.2% in 2025 Q2, as the effects of higher US tariffs and trade policy uncertainty start to drag on activity.

Following the fiscal reforms passed by the German Parliament, Bank staff expect a significant increase in German defence and infrastructure spending starting from 2025 H2, along with a smaller increase in defence spending by other euro-area countries. This increase in government spending is projected to provide a boost to euro-area GDP, which is expected to partially offset the negative activity impacts from trade policy developments by the end of the forecast period (Section 1.2).

Chinese GDP grew by 1.2% in 2025 Q1, following growth of 1.6% in 2024 Q4. This was slightly stronger than expected in the February Report and is judged to have reflected some temporary front-loading of exports ahead of higher US tariffs on Chinese goods. But the impacts of much higher tariffs and elevated trade policy uncertainty are expected to weigh on Chinese activity, and Bank staff project significantly weaker GDP growth of 0.3% in 2025 Q2. Near-term risks to Chinese GDP growth are two-sided. While an agreement between the US and China to lower tariffs, or additional Chinese fiscal stimulus, would present material upside risks to activity, there are downside risks related to a broadening of global trade barriers. Moreover, existing tariffs and elevated trade policy uncertainty could also lead to larger negative impacts on Chinese GDP growth, including through supply chain disruptions.

Chart 2.5: Global trade policy developments are projected to weigh on near-term global activity growth

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

• Sources: LSEG Workspace and Bank calculations.
• (a) See footnote (c) of Table 1.D for definition. The figures for 2025 Q1 to 2025 Q3 are Bank staff projections. These projections do not include the advance estimate of US GDP in 2025 Q1 or the preliminary flash estimate of euro-area GDP for the same quarter, as the data were published after the cut-off for incorporation into the forecast.

Inflation in the US is expected to pick up in the near term as a result of tariff policies, while euro-area inflation continues to slow.

Inflation in advanced economies has eased in recent years, following the peaks in headline consumer inflation rates in 2022. But at 2.3% and 2.2% in the US and euro area, respectively, headline inflation rates remain slightly above the respective central bank targets, largely due to elevated services inflation. Bank staff expect US PCE inflation to rise in coming quarters as increases in tariffs push up US import prices. Consistent with that, short and medium-term US household inflation expectations measures have risen recently.

Bank staff expect the disinflation process to continue in the euro area over coming quarters. In contrast with the near-term rise expected in UK CPI inflation (Section 2.5), HICP inflation in the euro area is not expected to pick up in the coming months. That is mainly because previous large falls in domestic energy bills in the UK, which did not occur to the same extent in the euro area, will fall out of the annual comparison from 2025 Q2, causing UK CPI inflation to rise. In addition, while the euro area and UK share common energy markets, the way in which energy is priced in the UK through the Ofgem price cap differs from that of other jurisdictions and can lead to more variation in the pass-through of higher wholesale energy prices to household energy bills. Part of the expected rise in near-term UK CPI inflation also reflects increases in indexed and regulated prices (Section 2.5), which are not expected to occur in the euro area.

2.2: Domestic credit conditions

Spreads on wholesale bank funding have risen a little in response to recent geopolitical news but remain close to their average levels over recent years.

In addition to taking deposits from households and firms, banks also fund themselves through issuance of debt in wholesale financial markets. Major UK banks tend to issue a lot of their wholesale debt in US dollars and euros, given debt markets are most liquid in these currencies. Spreads on UK banks’ wholesale funding have widened since the February Report, by around 40 basis points for senior unsecured debt issued in US dollars, in response to growing fears around the impact of higher tariffs on global economic activity. But this widening in spreads has been quite small relative to that observed in the Covid pandemic, markets have remained orderly, and wholesale bank funding costs remain close to their average levels over recent years.

Changes in reference rates continue to feed through to most household and corporate interest rates as expected.

Since the MPC began reducing Bank Rate in August 2024, interest rates on new corporate lending, for which Bank Rate is the main reference rate, have fallen by 70 basis points, in line with historical experience (Chart 2.6). Quoted instant-access deposit rates for households have only fallen by around 30 basis points over the same period. That low degree of pass-through is partly a consequence of low pass-through during the most recent Bank Rate tightening cycle, along with increasingly strong competition for deposits between banks. Meanwhile, quoted interest rates on representative credit card lending to households tend to respond to changes in Bank Rate very slowly and have remained around the same level since the start of the current cutting cycle.

Term OIS rates are materially lower than their peaks in 2023 Q3, despite a tick-up in these rates towards the end of last year. Quoted rates on two-year fixed-rate mortgages with loan to value (LTV) ratios of 75% and 90% have responded as expected to changes in OIS rates, falling by around 20 basis points and 35 basis points, respectively, since January 2025. Quoted rates on time deposits and personal loans have also continued to evolve as expected over this period.

Evidence from the 2025 Q1 Credit Conditions Survey suggests that households’ demand for secured borrowing and unsecured credit card borrowing continued to grow over the start of this year. But demand for secured lending was expected to stall in 2025 Q2, potentially reflecting a normalisation in activity following changes to Stamp Duty Land Tax in April (Section 2.3). Banks indicated that the availability of credit to households had grown in 2025 Q1 and that this was expected to continue into 2025 Q2. Credit availability for businesses had also grown in 2025 Q1 but was expected to remain broadly unchanged over the current quarter. The survey window did not capture the recent period of market volatility.

Chart 2.6: Pass-through of changes in reference rates has been broadly as expected over recent months

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 for personal loans and fixed-rate savings bonds, is the two-year OIS rate. The two-year OIS rate shows monthly averages, while Bank Rate shows month-end numbers. The provisional April 2025 data are shown in diamonds. For quoted rate series and the two-year OIS rate, these are based on average values to 29 April 2025. The provisional data for Bank Rate is based on the rate as of 29 April 2025. The final business loan rate data is shown for March 2025.

Despite falling quoted rates on mortgages, many households continue to face higher rates when they come to refinance.

Changes in the interest rates paid on existing UK mortgages are important in determining the strength of the cash-flow channel of monetary policy. All else equal, increases in effective mortgage rates, relative to rates paid on household deposits, will weigh on household consumption (Box C of the August 2024 Monetary Policy Report).

Effective interest rates paid on the stock of UK mortgages are continuing to increase (Chart 2.7, left panel), which, together with recent reductions in household deposit rates, means that monetary policy is judged to still be weighing on household consumption growth through the cash-flow channel. Effective rates on new mortgages with a fixed-rate period of between two and five years, which represent around 60% of the mortgage stock, remain around 130 basis points higher than the corresponding rates on outstanding mortgages (Chart 2.7, right panel). This means that households are facing higher interest rates when they come to refinance, which in turn is pushing up the effective interest rate on the average of all outstanding UK mortgages.

While monetary policy is judged still to be weighing on household consumption growth through the cash-flow channel, that effect is likely to be waning as rises in effective mortgage rates have slowed. The spread between the effective rates paid on new and outstanding mortgages has narrowed since 2023 and has turned negative for mortgages with a fixed period of up to two years. This means that fixed mortgage rates have been decreasing for some households. Together with reductions in floating mortgage rates, this has slowed the rise in the overall effective rate on the stock of UK mortgages (Chart 2.7, left panel).

Some of the impact of increases in effective interest rates on households’ monthly mortgage payments over recent years has been mitigated by mortgagors choosing to increase the overall term of their mortgages. Over half of new mortgage lending now takes place at a term of 30 years or more, compared with around 30% in 2015 (Waddell and Shrestha (2024)). Borrowers on longer-term mortgages pay less interest each month, but more interest over the life of their loans.

Chart 2.7: The effective interest rate on the stock of UK mortgages is still rising, but at a slower pace than in recent years

Contributions to the effective rate on the stock of mortgages and spreads between the effective rate on new and outstanding mortgage lending ^(a)

• Sources: Bank of England and Bank calculations.
• (a) Mortgage tenors refer to the initial fixation period. The ‘up to two years’ category includes mortgages with an initial fixation period of two years. The final data points are for March 2025.

2.3: Domestic activity

Underlying GDP growth is judged to have slowed and is expected to remain subdued in the near term.

Bank staff judge that underlying GDP growth, as measured by the collective steer from several business survey indicators, slowed over the second half of 2024 (Chart 2.8). The slowing in underlying GDP growth was less than implied by the headline data, which have been volatile recently. Headline GDP growth slowed more sharply in 2024 H2, largely due to a slowing in market sector output growth.

Underlying GDP growth is expected to have been around zero in 2025 Q1, as expected in the February Report, and well below Bank staff’s projection for headline GDP. The S&P Global UK composite output PMI and the BCC composite output index were below their historical averages in 2025 Q1. Survey respondents attributed that weakness to concerns about UK economic prospects. Following strong monthly GDP growth of 0.5% in February, partly driven by volatility in manufacturing sector output, headline GDP is projected to have risen by 0.6% in 2025 Q1, significantly above the estimated pace of underlying growth.

Official activity data are released with a lag and will not yet capture the impact of higher US tariffs announced in April. Survey data released following those tariff announcements have suggested some weakening in activity growth. The April S&P Global composite output PMI, which covered the period between 9 and 28 April, fell to its lowest level since September 2023. Much of the weakness in these responses appeared to reflect an expected negative impact of tariffs on activity. The April CBI composite output index rose somewhat in April, however. Overall, Bank staff expect underlying GDP to remain broadly flat in 2025 Q2, while headline GDP is expected to grow by 0.1%.

Chart 2.8: Underlying GDP growth has slowed and has been less volatile than growth in headline GDP

Three-month on three-month growth in GDP and quarterly GDP growth implied by business surveys ^(a)

• Sources: BCC, CBI, Lloyds Business Barometer, ONS, S&P Global and Bank calculations.
• (a) The final data point for three-month on three-month GDP growth is for the three months to February 2025. The aqua diamonds show Bank staff projections for headline GDP. The orange diamonds to 2024 Q4 show in-sample fitted values of the survey indicator model and diamonds for 2025 Q1 and Q2 show out of sample projections.

Business confidence has weakened further in recent months.

Measures of business confidence in 2025 Q1, including the S&P Global UK PMI future output index and the Deloitte CFO survey, had already fallen by around one standard deviation on average relative to 2024 Q3. Survey respondents over this period highlighted increases in employer National Insurance contributions (NICs) and uncertainty about its impact on the economy among their primary concerns. While heightened domestic uncertainty appeared to be the main driver of deteriorating business confidence, concerns about the global economy were also increasing.

Uncertainty has increased further since the rises in US tariffs in April. In the April S&P Global UK PMI survey, the first covering the period since the US tariff announcements, respondents attributed weakness in new export orders to heightened global uncertainty, particularly around trade policy and higher tariffs. And in the April DMP Survey, which was in the field from 4–18 April, the share of respondents reporting that uncertainty was high or very high was at its highest level since November 2022 (Chart 2.9, left panel), and global trade tariffs were reported to be a key source of uncertainty (Box C). The share of firms that cited US tariffs as one of their top three sources of uncertainty rose further following the announcement of the 90-day pause in higher tariff rates on 9 April. Nevertheless, the rise in uncertainty has been much smaller than the pickup in global trade policy uncertainty (Box C).

Heightened uncertainty, as well as a weak demand outlook, appears to be weighing on investment intentions according to Agency intelligence. Investment intentions for the year ahead have fallen recently and suggest slowing investment growth (Chart 2.9, right panel). Business investment is expected to grow at a subdued pace in the near term.

Chart 2.9: Business investment intentions have weakened, consistent with heightened uncertainty

Percentage of respondents to the DMP survey reporting high or very high uncertainty; four-quarter business investment growth and survey indicators of investment intentions ^{(a) (b)}

• Sources: Bank of England Agents, BCC, CBI, DMP Survey, ONS and Bank calculations.
• (a) DMP uncertainty measure is based on responses to the question ‘How would you rate the overall uncertainty facing your business at the moment?’. Latest data are for April 2025.
• (b) Survey measures are scaled to match the mean and variance of four-quarter business investment growth since 2000. Measures for 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 shows companies’ intended changes in investment over the next 12 months; last available observation for each quarter. The BCC measure is the net percentage balance of respondents reporting that they have increased planned investment in plant and machinery; 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.

Household spending growth has remained subdued, although real incomes have risen.

Real household disposable income has risen by 9.5% since 2022 Q2, and by 6.3% per head, as wage growth has been strong and past shocks to global energy and other goods prices have waned. Despite this increase in real incomes, household consumption has risen by just 1.3% over the same period. As a result, the aggregate household saving ratio rose to 11.6% in 2024 Q4, its highest level since the pandemic (Chart 2.10).

Chart 2.10: The household saving ratio has risen further

Household saving ratio ^(a)

• Sources: ONS and Bank calculations.
• (a) Saving as a percentage of total available household resources. The series is NRJS from the ONS. The final data point is 2024 Q4.

Much of the rise in the saving ratio since 2022 reflects the restrictive stance of monetary policy, as well as households choosing to smooth through rises in their real incomes following previous increases in the cost of living (Box E of the November 2024 Monetary Policy Report). Consistent with that, 27% of respondents to the March 2025 Bank of England/NMG survey reported that higher savings interest was a reason why they had saved more than usual over the past year (Chart 2.11). Just over one-third of respondents reported having saved more in order to rebuild their savings in case of emergencies. That might suggest a precautionary savings motive, although less than 10% of respondents said that they were saving more due to concerns about job loss. Evidence from individual-level data from the NMG survey suggests that household deposits are at or above pre-pandemic levels in real terms across the distribution of households, although aggregate data suggest that the ratio of household money to household incomes is below its pre-pandemic trend (Box D).

Chart 2.11: Survey evidence suggests higher savings have partly reflected households trying to rebuild savings in case of emergencies

Households’ stated reasons for saving more than usual over the past year, NMG survey ^(a)

• Sources: Bank/NMG survey and Bank calculations.
• (a) Results are based on responses to the question: ‘You said that you have saved more than usual over the last 12 months. What would you say are the main reasons for this increase?’. Respondents were able to select up to three reasons. ‘Don’t know’, ‘prefer not to say’ and ‘other’ responses have been excluded.

Indicators of household spending growth have been mixed in recent months. Retail sales have risen by 2.5% since the start of the year. But the headline GfK consumer confidence index has been subdued recently and fell in April to one standard deviation below its historical average, possibly reflecting higher household bills (Section 2.5), as well as heightened global uncertainty following the rise in US tariffs. Alongside this, in the March 2025 NMG survey, households’ expectations for the general macroeconomic situation in the year ahead declined relative to the September 2024 survey.

Bank staff expect consumption to have risen by 0.4% in Q1, and for growth to be modest at 0.2% in 2025 Q2. Further out, consumption growth is expected to pick up gradually, supported by a reduced drag from past rises in interest rates. This is consistent with a gradual decline in the saving ratio (Section 1).

Housing market activity has continued to strengthen, although housing investment growth remains weak.

Restrictive monetary policy has weighed on housing market activity and house price inflation, but these have picked up since their troughs in 2023. Monthly mortgage approvals for house purchases are currently just above their 2012–19 average. And having been broadly flat over 2023 and early 2024, house prices have since risen. The official ONS UK house price index increased by 1.5% in the three months to February, although timelier data from Nationwide and Halifax suggest some slowing in the pace of growth in the months ahead. The strengthening in housing market activity may partly reflect a fading drag from past rises in interest rates, as well as continued growth in household incomes. In addition, contacts of the Bank’s Agents noted that anticipation of increases in Stamp Duty Land Tax, which took effect from April, had accounted for part of the recent pickup in approvals. This was reflected in an increase in secured lending to households (Box D). Leading indicators of future housing market activity have softened somewhat, and the RICS new instructions to sell balance, which measures activity at the start of the housing chain, fell to its lowest level since July 2024 in March.

Despite strengthening housing market activity, housing investment growth has been weak and housing investment remained 2.5% below its pre-Covid level in 2024 Q4. The revised National Planning Policy Framework contained several measures designed to boost house building. Based on the OBR estimates of additional house building resulting from this policy change, Bank staff judge that these reforms will boost the level of housing investment by a little over 7%, and the level of GDP by around ¼%, by the third year of the forecast period, broadly similar to the OBR’s assessment.

Fiscal measures announced in the 2025 Spring Statement are expected to have little impact on GDP over the forecast period.

Measures announced in the Government’s Spring Statement 2025 are expected to have very little impact on the fiscal stance, and hence on projected GDP growth, over the three-year forecast period. Government spending plans have become more front-loaded, resulting in increased spending of £1.8 billion in 2026–27, before £3.6 billion of cuts in day-to-day spending are scheduled to occur in 2029–30, beyond the MPC’s forecast horizon. Defence spending has been increased from 2.3% to 2.5% of GDP by 2027–28, funded by a reduction in overseas aid. The boost to output from increased spending in 2026–27 is partially offset by policies to reduce tax avoidance and other minor tax revenue raising measures such as increased passport and visa fees. The Government has also announced a series of welfare reforms which largely occur beyond the forecast horizon.

2.4: The labour market and supply

Underlying employment growth has softened.

The ONS LFS estimate of employment increased by 0.6% in the three months to February. Despite a small tick‑up in response rates, LFS data remain volatile and highly uncertain (Box D of the May 2024 Monetary Policy Report). In an update published in April, the ONS noted that it intends to transition to the transformed Labour Force Survey in November 2026 at the earliest. This survey is intended as the long-term replacement for the LFS.

Underlying employment growth is judged to be somewhat weaker currently than implied by the LFS estimate. Bank staff have estimated a new statistical model that extracts a common signal from a broad array of survey measures of employment growth. This model is timelier and includes a broader set of indicators than the quarterly indicator model shown in Section 2.4 of the February 2025 Monetary Policy Report. The new model suggests that underlying three-month on three-month employment growth softened to around 0% at the start of 2025 (Chart 2.12). This is below estimated population growth, of around ¼% in 2025 Q1, and hence is consistent with a rising rate of unemployment or inactivity.

Chart 2.12: Underlying employment growth is judged to have softened

Measures of employment growth ^(a)

• Sources: Bank of England Agents, DMP Survey, HMRC, KPMG/REC/S&P Global 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. Shaded area represents the 95% confidence interval. Latest data are for the three months to February 2025 for the LFS and April 2025 for the other survey data.

In addition to concerns around the broader economic outlook, firms have cited April’s increase in employer NICs as a reason for weakness in employment growth. Survey evidence suggests that firms are utilising several margins of adjustment in response to the rise in employer NICs, including lower growth in employment (Box D of the February 2025 Monetary Policy Report and Section 2.5). The impact of higher NICs on employment appears to have been fairly small to date, however. That is consistent with the fact that, while the REC and PMI employment indicators fell sharply around the turn of the year ahead of the rise in employer NICs, they have since recovered somewhat.

The labour market has continued to loosen and there are tentative signs of slack emerging.

The LFS unemployment rate has been little changed recently and was 4.4% in the three months to February. Indicators of underlying unemployment, such as the claimant count, and measures of recruitment difficulties, have also been stable, while indicators of redundancy intentions have remained at low levels. The unemployment rate is projected to edge up slightly to 4.6% in 2025 Q2, before rising a little further over the forecast period (Section 1.2).

Job vacancies have been falling since mid-2022, although the pace of decline has slowed somewhat since the turn of the year. Alongside a modest pickup in unemployment, this has meant that the ratio of vacancies to unemployment has continued to fall. The vacancies to unemployment ratio is now judged to be a little below its equilibrium level (Chart 2.13, left panel), based on analysis by Bank staff (Stelmach et al (2025)) in which the real cost of posting a vacancy and hourly labour productivity determine the long‑run level of vacancies.

Consistent with labour market slack having opened up, several measures suggest that underemployment has increased. The net additional hours desired by workers, as a percentage of average hours worked, rose to its highest level since June 2015 in 2024 Q4. (Chart 2.13, right panel). And the marginal attachment ratio, which measures the proportion of the working-age population who are not currently in work or seeking employment but report that they would like a job, has been rising steadily since February 2024. These data are taken from the LFS and so should be treated with caution.

Chart 2.13: The vacancies to unemployment ratio is estimated to be below its equilibrium, while net additional desired hours have increased

Vacancies to unemployment ratio and its estimated equilibrium value and net additional desired hours as a percentage of average weekly hours ^{(a) (b)}

• Sources: AA/WARC Expenditure Report, ONS and Bank calculations.
• (a) The equilibrium V/U ratio is estimated using an error-correction model over the period 1982–2023. 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 final data points for both series in the chart are 2024 Q4, while diamonds represent projections for 2025 Q1.
• (b) 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. Latest data are to 2024 Q4.

Weak growth in labour productivity has weighed on GDP growth.

Growth in underlying output per worker has been weak in recent quarters, at 0.4% in the four quarters to 2024 Q4 (Chart 2.14). Output per worker based on the headline ONS measures for GDP and employment was flat over the same period. Output per hour, based on headline GDP and LFS total hours worked, fell by 0.5%.

As outlined in Box E of the February 2025 Monetary Policy Report, much of the recent weakness in productivity growth is judged to have reflected weaker growth in potential productivity. As discussed in that box, however, a reassessment of the economic factors likely to affect productivity, including Brexit and supply-side effects from the pandemic, cannot fully account for this weakness. Part of the unexplained weakness in productivity is therefore assumed to dissipate over the forecast period (Section 1.2). Box A explores a scenario where productivity growth is weaker than assumed in the baseline projection.

Chart 2.14: Labour productivity growth has been weak

Measures of four-quarter labour productivity growth ^(a)

• Sources: ONS and Bank calculations.
• (a) Underlying output per worker is based on Bank staff’s underlying measures of GDP and employment based on indicator-based models from Charts 2.8 and 2.12 for GDP and employment respectively. The final data points are for 2024 Q4.

A small margin of economic slack is judged to have opened up.

The recent weakening in GDP growth is judged to have resulted in a small widening in slack. That is consistent with recent signs of labour market slack having begun to emerge, as well as with survey measures of capacity utilisation that suggest an increase in spare capacity within firms (Chart 2.15, left panel). In addition, top-down estimates of the output gap based on statistical techniques imply a recent widening (Chart 2.15, right panel). Since spare capacity cannot be observed, there are large uncertainties around this judgement. The MPC projects a further widening in the margin of excess supply over the forecast period. Box A in Section 1 explores a scenario in which slack widens by more than in the baseline projection.

Chart 2.15: Measures of capacity utilisation are slightly below historical averages and output gap models signal a modest widening in economic slack

Survey indicators of capacity utilisation; model-based estimates of the output gap ^{(a) (b)}

• Sources: Bank of England Agents, BCC, CBI, ONS, S&P Global and Bank calculations.
• (a) Left-hand side chart measures are standard deviations from averages between 2000–19. The measures included in the swathe are from the Bank’s Agents, the BCC (non-services and services), the CBI (manufacturing (capacity); financial services, business/consumer/professional services and distributive trade (business relative to normal)) and S&P Global PMI (manufacturing (backlogs); services (outstanding business)). Sectors are weighted using shares in gross value added. The BCC data are not seasonally adjusted. The data are shown to 2025 Q1.
• (b) The model-based estimates of the output gap are based on a variety of multivariate filters whose mean values are standardised to the MPC’s estimate of the output gap. Relative to previous Reports, this chart now contains a greater number of filter models, resulting in a wider swathe. The final data point in the chart is 2025 Q1.

2.5: Wages and inflation

Headline private sector regular pay growth picked up at the end of 2024 and is slightly higher than underlying wage growth.

Annual private sector regular AWE growth was 5.9% in the three months to February, having risen in 2024 Q4 (Chart 2.16, left panel). While AWE growth was 0.4 percentage points below expectations at the time of the February Report, it is a little above Bank staff’s estimate of underlying wage growth of around 5¼% in 2025 Q1. Analysis by Bank staff suggests that most of the recent difference between the rates of AWE and underlying wage growth can be accounted for by compositional effects, due to changes in the sectoral and full-time mix of employees, and by base effects from unusually weak wage growth at the end of 2023. Small revisions mean that the pickup in AWE growth over 2024 H2 is slightly smaller than previously estimated (ONS (2025)), but the strength of AWE growth in the most recent data has been largely unaffected.

Chart 2.16: Official AWE growth picked up at the end of 2024, but underlying measures have been more stable and point to a slightly lower rate of pay growth

Measures of private sector wage growth ^{(a) (b)}

• Sources: Bank of England Agents, DMP Survey, HMRC, Indeed, KPMG/REC UK Report on Jobs, Lloyds Business Barometer, ONS and Bank calculations.
• (a) Private sector regular pay growth in the aqua line shows the ONS measure of private sector regular average weekly earnings growth (three-month average on same three-month average a year ago). Bank staff’s indicator-based model of near-term private sector regular pay growth is quarterly and uses mixed-data sampling (or MIDAS) techniques. A range of indicators inform the model, including series from the Bank of England Agents, the Lloyds Business Barometer, Indeed, ONS/HMRC PAYE payrolls and the KPMG/REC UK Report on Jobs. Indicators are weighted together according to their relative forecast performance in the recent past. Latest data points are for the three months to February 2025 for private sector regular pay and 2025 Q1 for the indicator-based model estimates. The Agents’ pay survey diamond shows respondents’ expected average pay settlements in 2025, weighted by employment and sector. The DMP diamond shows average expected pay growth one year ahead for respondents to the April 2025 DMP Survey. Pay growth projections are for 2025 Q1 to 2026 Q1.
• (b) DMP shows three-month average realised pay growth from the DMP Survey (three-month average on same three-month average a year ago). KPMG/REC shows average starting salaries for permanent staff compared to the previous month. The KPMG/REC index is mean-variance adjusted to ONS private sector regular pay growth over 2002–19 and is advanced by 12 months, which better reflects the leading relationship between the KPMG/REC index and the ONS measure of pay growth. HMRC Real-Time Information (RTI) shows median of private sector employee pay growth. Indeed shows annual average job title matched pay growth for UK job vacancies. Latest data points are April 2024 for the KPMG/REC index, March 2025 for Indeed and HMRC RTI, and April 2025 for the DMP Survey.

In contrast to the pickup in headline AWE growth in 2024 Q4, Bank staff’s indicator-based model of underlying pay growth has been relatively stable in recent quarters (Chart 2.16, left panel). Most indicators are consistent with pay growth of around, or a little above, 5%. Annual growth in median private sector pay derived from HMRC payrolls data, for example, was 5.4% in the three months to March, having fallen from around 6% over 2024 (Chart 2.16, right panel).

Underlying wage growth remains materially higher than would be expected based on some of its key determinants. One model estimated on pre-Covid data, which decomposes movements in underlying wage growth into contributions from inflation expectations, productivity and economic slack, suggests that underlying wage growth is higher than can be explained based on these components (Chart 2.17).

Chart 2.17: Underlying wage growth is higher than expected based on its key determinants

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

• Sources: Barclays, Citigroup, HMRC, Indeed, KPMG/REC UK Report on Jobs, Lloyds Business Barometer, ONS, YouGov and Bank calculations.
• (a) Wage equation based on Yellen (2017). Pay growth is Bank staff’s estimate of underlying wage growth also shown in Chart 2.16. Short-term inflation expectations are based on the Barclays Basix Index and the YouGov/Citigroup one year ahead measure of household inflation expectations and projected forward based on a Bayesian VAR estimation. Slack is based on the MPC’s estimates, informed by the vacancies to unemployment ratio. Productivity growth is based on long-run market sector productivity growth per head. Values may not sum due to rounding. The final data point is 2025 Q1 and based on staff projections.

Wage growth is expected to moderate over the course of 2025.

Indicators of wage growth and pay settlements suggest that annual pay growth will ease significantly over 2025. In the monthly DMP Survey data for April, reported annual wage growth among firms who typically reset wages in Q2 was 4.8%, around 1 percentage point lower than the average for these firms in the three-months to March, consistent with downward momentum in wage growth. And recent pay settlements data, from Brightmine, CIPD and the Bank’s own settlements databases, suggest that pay awards have been around 3% to 4% since the start of the year (Chart 2.18).

The rise in the National Living Wage (NLW) in April, of 6.7%, is expected to push up annual pay growth by around 0.2 percentage points from 2025 Q2. And contacts of the Bank’s Agents continue to cite the NLW as the largest factor exerting upward pressure on pay in 2025, although the impact varies by sector. Partly offsetting that, however, the increase in the rate of employer NICs is expected to weigh on wage growth as firms try to contain the rise in overall employment costs (Box D of the February 2025 Monetary Policy Report). The near-term impact of the rise in employer NICs on wages is expected to be relatively small on average across firms, although some contacts of the Bank’s Agents report that they are reducing the pay rates they offer by around 1 to 2 percentage points in response to the rise.

Annual private sector wage growth is projected to slow to 3.8% by the end of 2025, as the easing in the labour market and past falls in inflation expectations feed through to lower wage growth (Chart 2.16, left panel). Consistent with that, the latest intelligence from the Bank’s Agents points to average pay rises for 2025 of between 3.5% and 4%, in line with the average of 3.7% reported in the Agents’ annual pay survey conducted ahead of the February Report. And respondents to the DMP Survey in the three months to April expected pay growth for the year ahead to be 3.8%, down from 4.8% currently.

Chart 2.18: Indicators of pay settlements have moved lower in recent quarters

Growth in AWE private sector regular pay and measures of annual pay settlements ^(a)

• Sources: Bank of England Agents, Brightmine, CIPD, Incomes Data Research, Incomes Data Services, Industrial Relations Services, Labour Research Department, ONS and Bank calculations.
• (a) Private sector regular pay growth in the aqua line shows the ONS measure of private sector regular average weekly earnings growth (three-month average on same three-month average a year ago). Final data points are the three months to February for AWE private sector regular pay growth, April for Bank of England settlements database, March for Brightmine settlements and 2025 Q1 for CIPD expected settlements.

While the rise in employer NICs is expected to weigh on wage growth somewhat, the majority of firms’ adjustment is expected to come through lower profit margins in the near term.

In response to higher labour costs resulting from the increase in employer NICs, employers may adjust their profit margins, pass the additional costs on to consumers through higher prices, or mitigate these costs by reducing nominal wages or employment. Firms are expected to use these margins of adjustment to varying degrees (Box D of the February 2025 Monetary Policy Report), but most of the adjustment is assumed to come through lower profit margins in the near term.

Survey evidence since the February Report has been mixed but is broadly consistent with this judgement. Respondents to the March ONS BICS expected to absorb the cost of employer NICs through both lower margins and higher prices, although reducing headcount and limiting wage increases were also common responses. Contacts of the Bank’s Agents have suggested that, while margins are already somewhat compressed, they will decline further this year, due to higher employer NICs as well as costs stemming from the NLW and the Extended Producer Responsibility legislation. Likewise, respondents to the Deloitte CFO survey expected operating margins to decline over the year ahead, again partly as a result of the rise in employer NICs.

Headline CPI inflation was 2.6% in March.

Twelve-month CPI inflation was 2.6% in March (Chart 2.19), up slightly from 2.5% in December and a little below the February Report projection. Higher services inflation, reflecting volatility in airfares and increases in administered prices, as well as higher food price inflation, accounted for most of the rise in CPI inflation since December. Core CPI inflation, which excludes energy, food, beverages and tobacco, also rose from 3.2% in December to 3.4% in March.

Chart 2.19: CPI inflation was 2.6% in March and is expected to have risen in April

Contributions to CPI inflation ^(a)

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero, ONS and Bank calculations.
• (a) Figures in parentheses are CPI basket weights in 2025. Data are shown to March 2025. Component-level Bank staff projections are shown from April to September 2025. The food component is defined as food and non-alcoholic beverages. Fuels and lubricants estimates use Department for Energy Security and Net Zero petrol price data for April 2025 and are then projected based on the sterling oil futures curve.

CPI inflation is estimated to have risen in April due to higher energy bills, indexed and regulated prices and the impact of employer NICs.

Headline CPI inflation is expected to have risen to 3.4% in April and is projected to rise further to 3.7% by September. The single largest driver of the projected rise in inflation is household energy bills (Chart 2.20). The Ofgem energy price cap for the typical household rose from £1,738 in January 2025 to £1,849 in April 2025. The fall in the Ofgem price cap in April of last year will also drop out of the annual comparison, pushing up the annual inflation rate and raising the contribution of energy bills to headline inflation.

Besides the higher contribution from energy bills, increases in water bills, indexation of bills such as broadband and phone charges, and an expected impact from the higher rate of employer NICs also push up projected headline CPI inflation from April (Chart 2.20).

The near-term projection for CPI inflation is a little lower than in the February Report. This primarily reflects movements in sterling oil and gas prices, which have fallen since then (Section 2.1). This reduces the expected contribution of road fuel prices to projected headline inflation in Q2 and Q3 by around ¼ percentage points. The contribution of gas and electricity prices is also a little lower in 2025 Q3. The imposition of higher global trade tariffs is expected to weigh on UK CPI inflation, but there are large risks around this judgement (Box C and Section 1).

Chart 2.20: CPI inflation is expected to rise from 2025 Q2 onwards

Projected contributions to the change in CPI inflation from March 2025 ^(a)

• Sources: Bloomberg Finance L.P., Department for Energy Security and Net Zero, ONS and Bank calculations.
• (a) Component-level Bank staff projections from April to September 2025. The energy component includes fuels and lubricants and electricity and gas. The NICs bars show Bank staff estimates of the pass-through of the increases in employer NICs announced in Autumn Budget 2024 to headline CPI inflation. The other regulated/indexed component includes education, other transport services, other services for personal transport equipment and communication services. The water bills component includes water supply and sewerage collection. The food component is defined as food and non-alcoholic beverages excluding the estimated impact of the changes to employer NICs. The other goods component is defined as goods excluding energy, food and non-alcoholic beverages, water supply and the estimated impact of the changes to employer NICs on goods inflation. The other services component is defined as services excluding education, other transport services, other services for personal transport equipment, communication services, sewerage collection and the estimated impact of the changes to employer NICs on services inflation.

Core goods and food price inflation have been rising and are above their pre-Covid averages.

Core goods and food price inflation fell materially over 2023 and early 2024 following declines in the prices of key inputs such as energy and other raw materials but have increased in recent months (Chart 2.21). Annual core goods and food price inflation were 1.1% and 3.0% respectively in March, above pre-Covid average rates.

Data quality issues have emerged since the February Report that mean that some indicators of input price pressures should be treated with caution. In late-March, the ONS paused the publication of its producer price inflation data following the identification of a problem in its production (ONS (2025)). While the impact of this problem on other economic statistics is not yet clear, the ONS has stated that the CPI is unaffected, headline PPI is likely to be revised upwards and headline services PPI to be revised downwards. The main impacts on annual producer price inflation rates are expected to be in 2022 and 2023. These revisions will also affect the calculation of headline GDP, although the ONS has said that early indications do not point to a notable change in the recent economic trends seen in these data.

Chart 2.21: Core goods and food price inflation are projected to remain above their pre-Covid averages and services inflation is expected to stay elevated in coming months

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. Data are to March 2025. Bank staff projections from April to September 2025. Dashed lines represent the 2010–19 averages, which are 3.0%, 1.6% and 0.8% for services, FNAB and core goods respectively.

Indicators of imported and non-labour cost pressures have picked up slightly from subdued levels, but remain muted. The overall manufacturing PMI input price balance (aqua line in Chart 2.22) and input prices for the food and drink sector specifically (orange line in Chart 2.22) have both picked up since late 2023 but remain around their long-run averages. Over that time there have also been pockets of strength in certain commodity prices, including cocoa and coffee, and contacts of the Bank’s Agents report that raw material cost inflation is becoming modestly positive. Looking ahead, contacts noted that price competition among supermarkets is expected to increase in coming quarters, which may exert some downward pressure on food prices. Meanwhile, contacts of the Bank’s Agents have reported concerns that developments in global trade policies could potentially cause future volatility in exchange rates and imported product costs (Box E). Contacts have reported little impact from tariffs on domestic consumer prices so far, but have noted the potential for some discounting to occur in cases where UK producers have excess stock that was produced for export to the US.

Chart 2.22: Measures of goods input price growth have risen but remain around their historical averages

PMI input price balances ^(a)

• Sources: S&P Global and Bank calculations.
• (a) The underlying measures are input price net balances which ask firms whether the price of their inputs are higher, lower, or the same as the previous month. Values are shown as standard deviations from averages between 1992–2019. The final data points are for April 2025.

Higher labour costs are judged to be making an increasing contribution to core goods and food inflation. The share of respondents to the ONS BICS who report that labour costs are a reason for price rises has been rising in recent months for both the manufacturing and wholesale and retail sectors (Chart 2.23). Intelligence from the Bank’s Agents also points to labour costs playing an increasing role in core goods and food price inflation, with contacts relating this to elevated wage growth and the recent increases in the NLW and employer NICs.

Chart 2.23: Pay growth is increasingly cited as a driver of price increases among manufacturing and retail firms

Factors causing price increases, percentage share of firms ^(a)

• Sources: ONS and Bank calculations.
• (a) The question posed in the survey is ‘Which of the following factors, if any, are causing your business to consider raising prices in [the next month]?’. The series shown in the chart are three-month averages of the share of firms choosing each respective answer. Data are not seasonally adjusted. The final data point is taken from the April survey, Wave 130, which refers to the month of May.

Core goods and food price inflation are expected to remain elevated at above their pre-Covid average rates in coming months (Chart 2.21). In addition to the upward pressure on prices from input costs, both sectors face exposure to the Extended Producer Responsibility regulations, which come into effect from October of this year. Contacts of the Bank’s Agents report that they have already passed through some of the cost of these regulations but noted that further pass-through is possible in the second half of 2025. The food and hospitality sectors are expected to be particularly affected, due to their higher use of packaging.

Measures of underlying services inflation have continued to slow but remain elevated.

Annual services price inflation has fallen from its peak but remains elevated relative to past averages (Chart 2.21). Headline services price inflation has risen since December 2024, in part reflecting the introduction of VAT on private school fees and the rise in the cap on single bus fares in January, as well as volatility in airfares, but fell back slightly to 4.7% in March, somewhat below the February Report projection. Services inflation is expected to rise slightly to 5.0% in April, reflecting the impact of higher employer NICs, and higher sewerage bills, broadband and phone charges and Vehicle Excise Duty, before falling back a little to 4.6% in June. Notwithstanding volatility caused by airfares inflation, services inflation is projected to be broadly flat over the coming six months as the effects of higher employer NICs and indexed and regulated prices offset the impact of an easing in pay growth.

Measures of underlying services price inflation have been gradually easing since their peaks in 2023 but remain elevated (Chart 2.24). Results from a model estimated by Bank staff that allows for non-linear relationships between a large range of variables (Buckmann et al (2023)) suggests that, as the upward pressure from higher non-labour domestic input costs has faded (aqua bars in Chart 2.25), persistence from wage growth, inflation expectations and past inflation is now the main driver of continued high services inflation (orange bars). As inflation rose in the wake of the pandemic, and high rates of inflation began to influence wage negotiations, the contribution of this component rose sharply. Over time its estimated contribution has fallen but has not yet returned to its past average.

Chart 2.24: Underlying services inflation measures have continued to slow

Measures of underlying 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. All measures are seasonally adjusted. The trimmed mean measure excludes the 10% largest and 10% smallest price changes. The latest data points shown refer to March 2025.

Chart 2.25: The estimated contribution of inflation expectations and past wage and price growth to services inflation is declining but remains elevated

Contributions to model-implied services inflation relative to 1997–2019 average ^(a)

• Sources: OECD, ONS, World Bank and Bank calculations.
• (a) Outputs are from a machine-learning model based on a version of the model proposed by Goulet Coulombe (2024) and discussed in the Bank Underground post: Dissecting UK service inflation via a neural network Phillips curve. Model outputs show one quarter ahead out-of-sample forecasts. Quarterly growth rates are annualised and quarterly fluctuations are smoothed. Bars show contributions to the model-implied services inflation forecast (white line) relative to the mean of 3.3% between 1997 and 2019. Domestic input costs reflect the contribution from past domestic goods inflation, food inflation, energy inflation and input prices. Nominal inertia components include ONS private sector regular pay growth, past services inflation, selected services inflation subcomponents and output prices. Inflation expectations includes household and financial market-based measures of short and long-term inflation expectations. The output gap bars show the impact of a model-implied service inflation-relevant output gap estimate that reflects the contribution from a range of activity indicators as well as the Bank’s output gap measure. Contributions may not sum to total due to rounding. The latest data points are for 2025 Q1.

Households’ inflation expectations have continued to rise.

Inflation expectations can influence CPI inflation through their impact on wage and price-setting behaviour. The MPC monitors a range of indicators, including surveys of households and companies as well as those derived from financial market prices, to assess whether inflation expectations remain consistent with meeting the 2% inflation target in the medium term.

Having fallen significantly from the end of 2022, survey measures of short-term household inflation expectations have risen since mid-2024. Measures of medium-term inflation expectations have also risen. The Bank of England/Ipsos Inflation Attitudes Survey (IAS) measures of median one and five year ahead inflation expectations rose to 3.4% and 3.6%, respectively, in 2025 Q1, 0.4 and 0.3 percentage points above their 2010–19 averages (Chart 2.26, left panel). The Citi/YouGov measures of households’ short-term and medium-term inflation expectations have risen to more materially above pre-Covid averages (Chart 2.26, right panel).

Chart 2.26: Household inflation expectations have increased

Measures of household inflation expectations ^{(a) (b)}

• Sources: Bank/Ipsos Inflation Attitudes Survey (IAS), Citigroup, YouGov and Bank calculations.
• (a) Left panel shows the median responses from the Bank/Ipsos IAS. Data shown are the one year and five year ahead inflation expectations measures. Dashed lines represent the series averages over 2010–19. A methodological break occurred during the Covid pandemic that means a degree of caution should be taken when making long-run comparisons with these data. The methodology notes linked in the latest IAS release for February 2025 provide more information. Data are not seasonally adjusted and the latest data points are for 2025 Q1.
• (b) Right panel shows the monthly Citi/YouGov survey data. Data shown are the one year and five to ten year ahead inflation expectations measures. Dashed lines represent the series averages over 2010–19. Since August 2022, the YouGov/Citigroup survey has been based on updated response buckets. Data are not seasonally adjusted and the latest data points are for April 2025.

Increases in inflation expectations have been in line with, or a little above, what is implied by the rise in CPI inflation.

Bank staff analysis suggests that rises in short-term household inflation expectations have been towards the upper limit of what would be predicted by a model based on movements in subcomponents of the CPI basket and other economic factors. The estimates shown in Chart 2.27 are taken from models that use lags of food, energy, core goods and services inflation to predict movements in household inflation expectations based on pre-Covid data. The recent rise in short-term inflation expectations has been towards the upper end of what would be expected based on this approach (left panel), while the rise in medium-term expectations has exceeded what the model would suggest (right panel). These results provide tentative evidence that households’ inflation expectations have become more sensitive to price changes since the most recent period of very high inflation. That is consistent with estimates by Anesti et al (2025), which suggest that households’ inflation expectations tend to be more sensitive to price changes, specifically changes in food prices, following larger increases in inflation. Box A describes a scenario where elevated responsiveness of inflation expectations to CPI outturns generates second-round effects in CPI inflation that are greater than in the baseline projection.

Chart 2.27: Inflation expectations are in line with, or above, what past relationships would suggest

Citi/YouGov short and medium-term inflation expectations, model-predicted values and confidence intervals ^(a)

• Sources: Citigroup, YouGov and Bank calculations.
• (a) Aqua lines show model predictions for short and medium-term household inflation expectations. The dependent variables are quarterly averages of the monthly Citi/YouGov one year ahead (left panel) and 5–10 year ahead (right panel) expectations. The values for April 2025 have been held constant to populate the remaining months in 2025 Q2. The independent variables are lags of food, energy, core goods and services inflation, and controls for economic slack and supply chain disruption. The sample period for estimation is 2005 Q4–2019 Q4 and the confidence intervals shown by the swathes correspond to +/- 2 standard errors.

Businesses’ medium-term CPI inflation expectations have increased slightly since the start of the year.

CPI expectations of those responding to the DMP Survey have declined from their peaks in 2022 and were stable in 2024. In the three months to April, DMP firms reported one year and three year ahead CPI expectations at 3.2% and 2.8%, respectively, slightly higher than those at the time of the February Report. The average expectation for firms’ own price growth one year ahead was 3.8%, a little lower than at the start of the year but higher than the recent low of 3.5% in mid-2024. Meanwhile the Deloitte CFO survey measure of two year ahead CPI expectations was 2.6% in Q1, slightly higher than the 2.4% figure reported in Q4.

Chart 2.28: Businesses’ inflation expectations in the DMP Survey have risen a little in recent months

DMP measures of short-term and medium-term expectations for CPI inflation ^(a)

• Sources: DMP Survey and Bank calculations.
• (a) Solid lines show three-month moving averages and dashed lines show the single-month value. One year and three year ahead CPI inflation expectations are responses to the question: ‘As a percentage, what do you think the annual CPI inflation rate will be in the UK, one year from now and three years from now?’. The data are not seasonally adjusted and the latest data points are for April 2025.

Market participants’ expectations for near-term inflation fell in April, while medium-term market-based inflation compensation measures have also drifted lower.

Market participants’ near-term inflation expectations have declined since the February Report. The median respondent to the latest Market Participants Survey expected CPI inflation of 2.3% one year ahead, down from 2.5% in the February Survey. The median expectation for CPI inflation two years ahead was a little lower at 2.1%. Around 70% of respondents viewed recent tariff announcements as likely to weigh on UK CPI inflation. Medium-term inflation expectations derived from financial markets, such as the RPI-reform adjusted measure of five-year, five-year forward inflation compensation, have trended downwards over the past year and a half but remain a little above pre-Covid averages.

The MPC will continue to monitor closely developments in inflation expectations measures.

CPI inflation is expected to have risen sharply in April, accounted for by a higher contribution from energy prices alongside a number of other regulatory changes. Household inflation expectations are elevated and some appear to be higher than suggested by fundamental economic drivers. Firms’ inflation expectations are lower, but have risen slightly, while measures implied by financial markets have continued to trend downwards. With inflation set to rise further in coming months there is a risk that higher expectations add to the persistence of inflationary pressures (Box A).