UK growth upgraded but energy prices and rates to bite in 2027

The UK economy is forecast to grow by more than previously expected this year before higher energy prices and interest rates hit growth in 2027, the International Monetary Fund (IMF) has said.

The organisation's latest report, which is closely watched by the government, said the UK economy would expand by 1.3% in 2026, up from the 1% it predicted in July, before slowing in 2027.

Economies across the world have proved more resilient to the energy price shock caused by the US-Iran war, the IMF said, but it warned the economic fallout from the conflict remained "highly uncertain".

Chancellor John Healey said the government would look to "provide some breathing space" for households in the Budget.

Healey is making the final preparations to Andy Burnham's new-look government's tax and spending plans, which will be announced on 28 October.

Government borrowing costs have surged, placing pressure on the chancellor to ensure his plans are credible in the eyes of financial markets, which the UK relies on to borrow money.

But in its economic forecast, the IMF projected that the UK would have a sharp fall in borrowing and the lowest annual rate of borrowing of all G7 countries - the group of the world's most advanced economies - over the next five years.

The UK is estimated to have the lowest annual deficit - the difference between what the government spends and brings in through taxes in a year - by 2031, suggesting it thinks public spending will be cut in coming years.

The head of the IMF has previously called on the world's advanced economies to cut borrowing and reduce debt levels.

The reversal of downgrades to economic forecasts made at the start of the US-Iran, mean the UK is expected to have the second fasted growing economy in the G7 along with Germany.

But growth is estimated to slow in 2027 to 1.2% due to higher energy prices and long-term interest rates weighing on household spending and business investment.

Healey acknowledged that wars in the Middle East and Europe were "hitting people in the UK and around the world", but added that "Britain's economy is showing strong international resilience".

When the economy is growing, businesses tend to invest more, more jobs are created and people, on average, tend to feel better off. The opposite can occur if the economy stagnates or shrinks.

Economists have suggested Healey faces having to find £35bn to avoid cuts to public spending while meeting defence promises in his first Budget.

On Tuesday, the Resolution Foundation called on the chancellor to make "make repairs" to the public finances, but said well-targeted support was needed for those "struggling to heat their homes".

"The challenge of continuing to bring down borrowing must be paired with the pressing need for fresh cost of living support to help families facing a difficult winter ahead," the think tank said.

Andrew Griffith, Conservative shadow chancellor, said if Healey "reaches for more tax rises" in his Budget, "he is choosing slower growth and working people will pay for it".

Burnham has pledged to create "good growth in every postcode" as part of his plans to giving nations and regions more control, but his strategy has faced criticism inside his own party.

The IMF said households are likely to continue feeling the pinch of rising prices, with inflation expected to average 3.3% this year and remain above the Bank of England's 2% target in 2027 at 2.8%.

The Bank itself has predicted inflation could rise above 4% at the beginning of next year - making it more likely that interest rates will rise.

Healey is expected to meet with other finance ministers at the IMF's annual meeting in Bangkok, Thailand, on Tuesday to discuss how the economic impact of the Middle East and European conflicts could be limited.

The IMF said the global economy had shown a "remarkable capacity to absorb shocks" not just from the current Middle East conflict, but also from the Covid pandemic and Russia's invasion of Ukraine.