4Q 2025 UK Economy Overview
Having been forecast by the Bank of England (BoE) to peak at 4.0% in September, before undershooting in that month at 3.8%, inflation fell in successive months in Q4, as headline CPI slowed to 3.6% in October and 3.2% in November. Having reached a low of 1.7% in 2024 and staying close to the 2% central bank target for much of 2024, inflation in 2025 increased through to this autumn, owing largely to higher food and administered prices, alongside a swing in energy prices from falling to moderately increasing. Administered prices are charges set or tightly controlled by government or regulators - for example, water bills, Vehicle Excise Duty, regulated rail fares, and energy bills constrained by Ofgem’s cap - rather than prices set in competitive markets. Separately, employers’ National Insurance Contributions (NIC) lifted labour costs, lifting services inflation even as broader underlying pressures eased. In the central projection published in the November Monetary Policy Report (MPR), headline CPI inflation is projected to fall to close to 3% in the coming quarters and then decline gradually towards the 2% target after that.
In conjunction with a loosening of some labour market metrics, pay growth eased in the second half of 2025. Annual growth in Average Weekly Earnings (AWE) declined in terms of both the whole economy and private sector wage growth. Pay growth in the private sector – a measure closely tracked by the BoE – fell to 3.9% in the three months to October, from 4.2% previously. The BoE expects this metric to fall further, predominantly owing to base effects, which reflected the strength in pay growth at the end of 2024 when private sector wage growth peaked at 6.2%. The unemployment rate rose to 5.1% in the three months to October, slightly overshooting the BoE’s projection of 5% over Q4. The BoE has relied on a broader set of indicators away from the Labour Force Survey, given recent issues around data collection and the potential for volatility as a result. The tax data from HRMC showed the number of employees on payroll fell by 38k in November, following a 22k decline in October. This data, too, is subject to significant revisions. On a year-to-date basis, payrolls are down by 112k, with a private sector decrease of close to 260k, offset by an increase in public sector jobs.
Growth in the UK slowed in H2 as Q3 GDP was confirmed to have slowed to 0.1% QoQ, from 0.3% in Q2 and 0.7% in Q1. The meagre growth in Q3 also fell below the BoE’s expectations of a 0.2% gain. Monthly data showed output declined in both July and September, with the latter month’s growth figure affected by a sharp drop in car production following a cyberattack at Jaguar Land Rover. The loss of production is estimated to have subtracted about 0.2% from the headline monthly growth figure after the section of manufacturing that includes motor vehicles fell by 28.6% during the month. The same monthly series also indicates that Q4 may have started off poorly after a 0.1% MoM contraction in October.
In November, the chancellor, Rachel Reeves, delivered the highly anticipated budget. Aided by the Office for Budget Responsibility’s (OBR) pre‑budget forecasts, which proved to be less constricting than feared, Reeves was able to double the headroom under the self-imposed fiscal rules to about £21.7 billion (0.6% of GDP)—up from roughly £10 billion in March—while still raising spending in each year of the Parliament. The adjustment relies on tax measures worth around £26 billion a year by 2029/30, including an extended freeze on income tax thresholds(+c.£8bn), NICs on salary‑sacrifice pensions (+c.£4.7bn), and targeted levies such as an online gaming tax and a surcharge on non‑labour income. Much of the consolidation is deferred, with nearly £18bn of the buffer achieved in the final year, leaving questions over medium‑term credibility even as markets welcomed the larger cushion. The OBR’s forecasts and publication process themselves drew scrutiny after a pre‑release leak prompted an investigation and the chair’s resignation.
UK Interest Rate Markets
At its December meeting, the BoEs Monetary Policy Committee (MPC) voted by a narrow 5–4 margin to cut the Bank Rate by 25 basis points to 3.75%, marking the fourth reduction in the current easing cycle. The restrictiveness of policy has fallen as the Bank Rate has been reduced by 150 basis points since the current cutting cycle began in August 2024. The decision was described as “finely balanced” in the minutes, with Governor Andrew Bailey casting the deciding vote after a split among members highlighted growing divergence on the appropriate pace of policy adjustment. In the accompanying statement, the MPC reiterated that “monetary policy will need to remain restrictive for sufficiently long to return inflation to the 2% target” and emphasised that future decisions will continue to be taken on a meeting-by-meeting basis. The tone of the statement was notably cautious, signalling tha t while the degree of restrictiveness has diminished, the Committee remains alert to risks around inflation persistence and second-round effects. Forward guidance retained its data-dependent stance.
UK Gilts endured a rollercoaster year in 2025 as yields at multiple tenors in the intermediate to longer sections of the curve reached multi-decade highs. Drivers of yield selloffs over the year included scepticism over global rate cuts in January, the “Liberation Day” rollout of tariffs in April and concerns over fiscal discipline from the Labour government in August/September. Ultimately, gilts ended the year on a resilient note as BoE’s December cut and softer inflation metrics supported duration, while the Autumn Budget was received positively - headroom proved larger and the gilt remit smaller - reducing near‑term supply anxiety. Against that backdrop, where the 10-year gilt yield fell from 4.7% at the end of September to 4.48% by year-end, the ICE BofA UK Gilt Index had a total return of 3.22% in Q4. On an annual basis, the Gilt index had a total return of 5.00% in 2025, its strongest annual performance since 2020. Sterling‑denominated investment‑grade credit fared even better, as the spread on the ICE BofA Sterling Corporate Index tightened by 11bps over the year, to end the year at 80bps. Accordingly, the ICE BofA Sterling Corporate Index produced a TRR of 7.0% over 2025, with an excess return over risk‑adjusted gilts of 1.68%.
UK equities posted a strong year, with the FTSE 100 up ~25.7% in total return terms, aided by a late‑year recovery in risk appetite and a smoother reception for the Autumn Budget. Sterling appreciated against the US dollar, with GBP/USD +7.7% over 2025 as the dollar weakened, but fell against the euro (-5.1%) amid relative euro strength. Performance was choppy through mid‑year—headline tariff and fiscal news weighed at times—before Q4 gains in equities and broader FX moves left UK assets finishing the year firmly in positive territory.
