UK risks higher inflation becoming entrenched, IMF warns

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The International Monetary Fund has warned that the risk of over-target inflation is entrenched in the UK, with the country expected to see the highest price growth of any G7 country over the next two years.

The Fund’s chief economist said the Bank of England should be careful about cutting interest rates before it curbs the latest outbreak of inflation, adding that the central bank is likely to hold off on further cuts in the key interest rate until 2026.

In its World Economic Outlook report, the Fund expected UK consumer prices to rise annually by 3.4 percent this year and 2.5 percent next year, faster than other G7 countries including the United States, where prices have risen due to tariffs imposed by President Donald Trump. The Bank of England expects inflation to peak at 4 percent later this year.

The Bank of England kept its key interest rate at 4 percent last month, as the Monetary Policy Committee gauges how to respond to inflation, which reached 3.8 percent in August – well above the bank’s official target of 2 percent.

“One has to be very careful,” said Pierre-Olivier Gorinchas, chief economist at the International Monetary Fund. It is important to ensure that “this increase in inflation that we saw last year, which we consider temporary, actually turns out to be temporary.”

The Fund raised its forecast for UK GDP growth this year to 1.3 percent, expecting expansion to continue at the same pace in 2026. This means that the United Kingdom will be the fastest growing G7 economy in 2025 after the United States. It will lag behind the United States and Canada next year, according to the International Monetary Fund.

The IMF forecast is broadly in line with those of economists polled by Reuters, who forecast UK growth of 1.3 per cent this year and 1.2 per cent next year. Last month, the OECD forecast that the UK economy would grow by 1.4 percent this year and 1 percent in 2026.

Gorinchas said that IMF forecasts assume that the Bank of England will leave the key interest rate at 4 percent for the rest of the year, before resuming interest cuts “after making further progress in lowering inflation and inflation expectations.”

He added that the Fund expects the Bank of England to reduce the cost of borrowing four times next year, with a final interest rate of 3 percent. The IMF’s central forecast was that recent gains in UK inflation would be “mostly temporary” but there were upside risks.

“The one place we have to watch carefully is what happens with labor costs and what happens with inflation expectations,” Gorinchas said. He added that long-term inflation expectations are “trending higher.”

The latest Bank of England/Ipsos Inflation Attitudes Survey showed that individuals expect inflation of 3.6% next year, up from 3.2% in May 2025. When asked about long-term inflation expectations, respondents gave an average answer of 3.8%, up from 3.6% in May 2025.

In a letter to Chancellor Rachel Reeves after the central bank’s vote last month, Bank of England Governor Andrew Bailey blamed the government for contributing to recent increases in inflation.

Efforts to contain rising labor costs “appear to have been delayed” by the £25bn increase in employers’ National Insurance contributions set out in last October’s Budget and the jump in the minimum wage, Bailey wrote.

Speaking at a conference in Washington hosted by the Institute of International Finance lobby group, Bailey said there were signs of some “softening” in the UK labor market but this came alongside inflation above target.

So-called targeted prices such as water, energy and transportation costs have helped push inflation higher, as have higher food costs.

Megan Green, an outside member of the Monetary Policy Committee, said on Monday that the Bank of England should wait until next year before cutting interest rates again, warning that although the disinflation process remains intact, it “may be slowing down.”

This is partly because households’ memories of the jump in inflation above 10 per cent are still fresh, which may influence their response to new signs of rising prices.

Reeves has stressed the importance of lowering inflation as it prepares for what could be a difficult Budget next month.

Gorinchas said the UK’s fiscal position was “relatively sound”, adding that the UK was on track to ensure a stable debt-to-GDP ratio later this decade.

Responding to the IMF’s growth forecasts, Reeves said: “This is the second successive upgrade to this year’s growth forecasts from the IMF. It is no surprise that Britain led the G7 in growth in the first half of this year, and average disposable income has risen by £800 since the election.”

But the shadow finance minister, Sir Mel Stride, said the IMF forecast “makes for bleak reading”.

He said: “UK inflation is now set to be the highest among the G7 this year and next – and will rise faster than expected because of the choices made by Rachel Reeves.”

Additional reporting by Valentina Romei in London