The Organisation for Economic Co-operation and Development (OECD) anticipates that the Bank of England will keep its benchmark interest rate steady throughout this year, despite rising inflation. This forecast is based on the view that the inflationary impact from energy costs will be "transitory," while the UK's persistently weak labor market will contain upward price pressures.
In its latest set of projections, the OECD, often regarded as a think tank for developed economies, stated that the UK central bank is expected to cut rates by 25 basis points to 3.5% in 2027, even as inflation remains above its 2% target. The organization's GDP forecasts show little change from its March estimates, with the growth outlook for this year slightly upgraded from 0.7% to 0.9%. However, the forecast for 2027 has been modestly revised down from 1.3% to 1.1%.
The OECD believes that, driven by temporary inflation and limited stimulus, the UK will remain the third-fastest growing economy among the Group of Seven nations this year, trailing only the United States and Canada.
The organization has urged the UK government to advance fiscal consolidation and ensure that any support provided to households during the energy shock is well-targeted. This recommendation comes as national debt continues to swell. The OECD projects the debt-to-GDP ratio will rise sharply from 98.8% in 2023—the year before the Labour Party assumed power—to 105.4% by 2027.
According to the OECD, the UK remains more vulnerable than any other G7 economy to the adverse effects of inflation. It forecasts average consumer price increases of 3.7% this year and 2.4% next year, figures slightly lower than its predictions from March, which were issued just as geopolitical tensions in the Middle East began to escalate.
The organization warned that inflation will "squeeze UK domestic real incomes and heighten uncertainty, dragging on private consumption and investment." It also expects the UK unemployment rate to rise from 5% this year to 5.5%, before edging down slightly to 5.3% by 2027.
The OECD advises that, even if inflation continues to climb this year, the Bank of England should look through this effect rather than respond with higher interest rates. Additionally, the central bank should continue its quantitative tightening program in 2027, maintaining the current pace of selling assets from its balance sheet at a rate of £70 billion (approximately $94.4 billion) per year.
OECD's Outlook Versus Market Expectations
The OECD's forecast stands in contrast to current market expectations, which anticipate a 25-basis-point rate hike by September. Bank of England Monetary Policy Committee hawk Megan Greene hinted on Tuesday that she might soon join the camp led by the central bank's Chief Economist Huw Pill in voting for a rate increase. This contrasts with Governor Andrew Bailey and several other colleagues, who maintain they have time to wait and observe how the inflationary impact from energy prices, influenced by conflicts such as the war involving Iran, develops before taking action.
The OECD predicts that the European Central Bank and the Reserve Bank of Australia will implement rate hikes in the near term, while the U.S. Federal Reserve is expected to keep rates on hold for an extended period. This suggests global policymakers may once again begin to diverge in their approaches this year.
In contrast, interest rate futures traders hold a more aggressive stance. Pricing from the FedWatch Tool indicates traders are nearly fully pricing in a 25-basis-point Fed rate hike by December of this year.
Policy Trajectory and Recommendations
The OECD stated, "Monetary policy is projected to ease further, with the Bank of England looking through the energy shock in 2026 and moving to a neutral stance in 2027 as underlying price pressures ease." "Fiscal policy will remain restrictive given high borrowing costs, large debt interest payments, and rising public debt."
The organization also urged the government to "reduce long-term vulnerability to imported energy price inflation" by strengthening energy security. It added, "Correcting price signals that hinder electrification, accelerating grid capacity expansion, and enhancing short-term flexibility in the energy mix will enable clean power generation to reliably replace gas supply."
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