Street Calls of the Week
Inflation in the UK is at real risk of becoming entrenched. Despite restrictive monetary policy and sluggish growth, price pressures are refusing to fade.
This persistence threatens to harden inflation expectations and prolong a period of economic discomfort for both households and businesses.
The annual inflation rate has now held at 3.8% for three consecutive months, with core inflation near 3.5%. These are not figures that signal progress. They are a warning that the inflation problem is proving far more resilient than policymakers anticipated.
The underlying cause is structural. The UK’s productivity growth remains weak while wage increases continue to outstrip output in many industries.
When wages rise faster than productivity, the result is predictable: firms pass higher costs onto consumers, prices rise further, and inflation begins to feed on itself.
This is how inflation becomes a feature of an economy rather than a temporary phase. The longer it stays elevated, the more it shapes behavior. Businesses set prices in expectation of future cost increases. Workers seek larger pay rises to protect their purchasing power. Investors adjust portfolios based on higher nominal returns. Over time, these choices reinforce one another.
This is the risk now facing the UK. It is not simply that inflation is too high today; it is that expectations are shifting toward believing it will remain high tomorrow. Once that mindset sets in, the task of bringing inflation down becomes vastly more complex.
The Bank of England faces a difficult challenge. Markets are currently pricing in rate cuts within months, yet that confidence looks premature. The central bank cannot credibly loosen policy while inflation remains nearly double its 2% target. The risk of easing too soon outweighs the discomfort of holding steady for longer.
If the Bank were to cut rates before inflation clearly retreats, it would invite renewed price pressures and undermine public trust in its commitment to price stability. Inflation expectations would rise, and that would demand even tighter policy later to restore credibility. In that scenario, the economic pain would only deepen.
For this reason, the most realistic outlook is that interest rates will remain elevated until well into 2026. There is even a real possibility that the next move will be an increase rather than a reduction.
Some point to weak GDP figures as justification for policy relief. Output expanded by only 0.1% in August. However, that cannot be interpreted as a signal for the Bank to act. Slow growth and sticky inflation together define a policy trap.
Loosening to support growth risks reigniting inflation; tightening to curb inflation risks choking off what little momentum exists. It is a deeply uncomfortable position for policymakers, but there are no easy exits from it.
Fiscal policy adds another layer of complexity. The Autumn Budget later this month will shape the inflation outlook. If the Chancellor announces measures that restrain demand, such as targeted tax increases or spending restraint, it would support the Bank’s efforts. However, if the focus is on stimulating activity through expansionary fiscal choices, the Bank will have to maintain or even strengthen its restrictive stance. Monetary and fiscal policy are now closely interdependent.
Beyond policy choices, the broader challenge lies in the UK’s weak productivity. Without faster gains in efficiency and output per worker, the country risks remaining trapped in a cycle of high wages and low growth. Sustained inflation would erode competitiveness and deter long-term investment, both domestic and foreign.
The result could be a prolonged period of stagnation that reduces real incomes and weakens the public finances.
The next year will therefore be decisive for inflation control. If the current price pressures are allowed to persist, they could become embedded in expectations across the economy. Once that occurs, inflation becomes self-reinforcing. Businesses raise prices pre-emptively. Workers demand higher wages.
Those higher wages feed into further price increases. This feedback loop is precisely what plagued the UK in the 1970s, and it took years of strict policy to unwind it.
Complacency would be a costly error. There is a growing tendency among investors and policymakers to assume that inflation will naturally drift lower as energy prices stabilize and supply chains normalize. That assumption has already proved unreliable.
The UK’s inflation problem is not driven primarily by external shocks anymore; it is being sustained internally by structural factors such as productivity weakness, labor shortages, and sector-specific wage pressures.
The central bank’s credibility depends on recognizing this reality and responding accordingly. Holding rates high for longer will be unpopular, but it is necessary to avoid a more damaging outcome later. The alternative would be to risk a resurgence of inflation, a loss of confidence in monetary policy, and the need for even more aggressive tightening further down the line.
Investors should therefore prepare for an extended period of restrictive policy. The conditions that would justify rate cuts are not yet in place, and may not be for many months. Until inflation is clearly and consistently moving toward target, the Bank of England’s priority must remain stability, not stimulus.
The UK is approaching a critical period for long-term price control. The task now is to prevent inflation from hardening into the fabric of the economy.
Once that happens, it shapes every decision that follows, from wage bargaining to investment planning. The Bank must hold its course firmly, even if the path ahead feels uncomfortable.
The evidence points to one conclusion: inflation in the UK is proving more stubborn than many expected, and interest rates are likely to remain elevated well into 2026. There is even a reasonable chance that the next policy adjustment could be upward rather than downward.
That is not the outcome markets want to hear, but it is the one consistent with the data. The fight against inflation is not over. It may, in fact, only just be entering its most difficult phase.