Interest rates in the UK are projected to fall more gradually than anticipated over the next two years, following Chancellor Rachel Reeves’ announcement of extensive public spending and borrowing measures in the October budget.

This update comes from the Organisation for Economic Cooperation and Development (OECD), which released its annual economic survey on Wednesday, offering a mixed outlook on the UK economy.

The OECD highlighted that inflation would exceed earlier estimates in 2024, though the economy’s growth prospects received a slight boost thanks to the government’s fiscal strategy.

The report projects UK gross domestic product (GDP) growth of 0.9% this year, a downward revision from its earlier 1.1% forecast, citing sluggish economic performance in the third quarter, where growth was just 0.1%.

However, there is a silver lining. “Momentum is positive nevertheless, with retail sales on an upward trend since early 2024,” the OECD report noted.

GDP growth is expected to accelerate to 1.7% in 2025, bolstered by the substantial increase in public expenditure outlined in the budget, before easing to 1.3% in 2026.

Inflation and Spending Drive Interest Rate Revisions

The OECD’s analysis also suggests that inflationary pressures remain significant. It revised its 2024 inflation forecast for the UK to 2.7%, up from the previously expected 2.4%. By 2026, inflation is anticipated to fall to 2.3%, though still above the Bank of England’s 2% target.

As a result, the OECD foresees the Bank of England’s base interest rate, currently at 4.75%, dropping to 3.5% by early 2026. This reduction is less steep than earlier predictions due to higher-than-expected consumer spending, a byproduct of the government’s expansive fiscal policies.

“Fiscal policy will be tightening over 2024-26, though by less than expected,” the report stated. It attributed this to “significant fiscal loosening in the tax, spending, and borrowing package announced at the autumn budget.”

The OECD’s outlook extends beyond the UK, forecasting a global economic growth rate of 3.2% this year and 3.3% next year, reflecting slight improvements from its previous estimates.

However, the organization cautioned that “risks and uncertainties are high” and warned of potential headwinds that could disrupt this trajectory.

In the UK, Chancellor Reeves emphasized the importance of sustained growth, asserting that it remains the government’s top priority. “Growth is our number one priority, and the OECD upgrade will mean the UK is the fastest-growing European economy in the G7 over the next three years,” she said.

Reeves also outlined a broader strategy to strengthen the economy, including establishing a national wealth fund, reforming regulatory frameworks, and incentivizing investment through pension mega-funds. “This government will get our economy growing,” she said, adding that these measures aim to ensure “more money in people’s pockets” while fostering long-term prosperity.

Despite the tempered outlook, the OECD’s projections underscore the UK’s resilience in navigating economic challenges. While inflation and interest rate dynamics remain pivotal concerns, the government’s ambitious spending plans offer a potential pathway to sustained growth.

The balancing act between fiscal expansion and monetary tightening will shape the UK’s economic landscape in the years ahead, as policymakers aim to rebuild the economy while addressing persistent inflationary pressures.