Yael Selfin, Chief Economist at KPMG UK, said:
“Households have so far shown resilience, with spending supported by warmer weather and people drawing on their savings. But as energy bills rise and wage growth slows, households' spending power is likely to come under increasing pressure.
“The longer-term challenge is how to sustain stronger growth as the contribution from a growing labour force diminishes. This makes investment in productivity-enhancing technologies, including AI, increasingly important.”
Energy prices to keep inflation elevated
Higher wholesale gas prices are likely to feed through to household energy bills over the coming months, putting renewed upward pressure on inflation.
The Ofgem energy price cap is forecast to rise by around 4% this autumn, with the Government’s reduction in VAT on household energy bills only partially offsetting the increase.
KPMG expects CPI inflation to rise to around 3.5% this autumn before peaking at around 4% in the first quarter of 2027.
If energy markets stabilise and flows from the Gulf recover, inflationary pressures from higher energy prices are likely to ease in the second half of 2027, helping inflation return towards the Bank of England's 2% target by year-end.
Bank of England faces difficult trade-off
The projected rise in inflation presents a challenge for the Bank of England, which is balancing higher energy prices against a weaker labour market and subdued underlying domestic inflation. The Bank is expected to raise interest rates before the end of 2026, most likely at its November meeting, taking the base rate to 4.0%.
The Bank could then resume its rate-cutting cycle from summer 2027 as the impact of higher energy prices fades and inflation moves back towards target. KPMG forecasts the base rate to fall to 3.25% by the end of 2027.
Chancellor faces limited room for manoeuvre ahead of October Budget
The Chancellor will have limited scope to provide significant support for growth or the cost of living when the Budget is delivered next month, as higher borrowing costs and weaker growth have reduced the Government’s fiscal headroom.
The rise in borrowing costs following the conflict in Iran has already reduced the £23.6 billion of headroom recorded at the Spring Forecast by around £9 billion. Weaker growth and a likely downgrade to the OBR’s projections could reduce it by a further £2 billion, leaving potentially around £12 billion in the autumn.
Restoring the previous level of headroom could require tax rises or spending reductions. With the Government committed to not increasing taxes on working people, the Chancellor may need to consider other tax measures.
Greater regional investment could help narrow the UK’s growth gap
KPMG's analysis suggests that increasing capital spending in England's seven most underfunded regions could raise UK GDP by up to £25 billion over the next five years, helping to narrow regional productivity gaps and support stronger long-term growth. Achieving this would require around £47 billion of additional investment to bring those regions up to the national average level of capital spending per head.
While public investment alone is unlikely to eliminate longstanding regional disparities, it could play an important role in improving infrastructure, boosting productivity and attracting further private sector investment.
Yael Selfin, Chief Economist at KPMG UK, said:
“Greater public investment has an important role to play in narrowing the UK’s longstanding regional economic divide, particularly where gaps in infrastructure are holding back productivity. The effectiveness of individual projects, alongside stronger private sector investment and credible local growth strategies, will be crucial in turning additional public spending into sustained improvements in productivity and living standards.”
