Growth, Inflation and the Labour Market – March 2026

This month’s economic update reviews recent developments in UK growth, inflation, the labour market, productivity, and business investment. Together these indicators provide insight into the current trajectory of the UK economy and the potential direction of future monetary policy decisions. Global trade developments, particularly those linked to US tariff policies, also remain an important backdrop for economic uncertainty.

UK growth remains modest

The UK economy recorded 0.1% growth in the final quarter of 2025, matching the pace seen in the third quarter. While growth remains modest, it allowed the economy to close the year on a stable footing. Overall GDP growth for 2025 reached approximately 1.3%, slightly stronger than the 1.1% recorded in 2024 and above the sub-1% growth many analysts expected at the start of the year.

Several factors supported economic activity during 2025. Household spending, government expenditure, and increased capital investment all made positive contributions to growth, with business investment also strengthening during the year. Although household spending remained relatively cautious, it still represented the first annual increase since 2022, suggesting consumer confidence may be slowly improving.

However, the UK’s net trade position continued to weigh on growth. Imports expanded faster than exports throughout the year, reducing overall GDP growth by nearly one percentage point. This marked the largest negative contribution from trade since 2014.

Sector performance in the final quarter was mixed. Manufacturing output recovered after disruption earlier in the year linked to the cyber-attack affecting Jaguar Land Rover operations. The services sector remained broadly flat, representing its weakest quarterly performance in around two years. Consumer-facing services saw slight growth, but this was offset by declines in business-related services such as professional and technical activities.

The construction sector experienced the most significant decline, with output falling by more than two percent during the quarter. This represented the sector’s weakest performance in over four years and reflected weaker activity in housing construction as well as repair and maintenance work. Recent survey data had already indicated a slowdown in construction, and early indicators for 2026 suggest the sector remains under pressure.

Labour market softening

The UK labour market has gradually cooled over the past year. Unemployment rose steadily throughout 2025, increasing from 4.4% at the beginning of the year to 5.2% by December. This is the highest level seen outside the pandemic period in over a decade.

Business surveys have pointed to reduced hiring intentions across several sectors. However, the increase in unemployment has also been influenced by more individuals moving from economic inactivity into the labour force, but not immediately securing employment.

Evidence from the Bank of England suggests many companies are adjusting workforce levels through natural attrition rather than large-scale redundancies. As a result, a significant proportion of unemployment remains short term, with workers moving back into employment relatively quickly. Job vacancies, which had been declining since mid-2022, have also shown signs of stabilising in recent months.

One notable trend has been the increase in youth unemployment. By the end of 2025, unemployment among those under the age of 25 had reached approximately 14%, its highest level in nearly a decade.

A number of factors may be contributing to this rise. Increasing adoption of automation and artificial intelligence may be reducing demand for entry-level roles in some industries. Employers may also be cautious about recruitment ahead of upcoming employment legislation, while recent minimum wage increases may be affecting hiring decisions for younger workers in certain sectors.

Some smaller businesses have highlighted concerns that the cost of hiring and training younger employees can outweigh productivity gains in the early stages of employment. In response, the government has signalled it may review the timeline for aligning minimum wage bands across age groups, given the potential impact on youth employment.

Looking ahead, the Bank of England now expects average unemployment to reach around 5.3% during 2026, slightly higher than previous forecasts. Wage growth has also begun to slow, which could help reduce inflationary pressure and potentially create room for interest rate reductions later in the year.

Inflation shows signs of easing

Inflation declined at the start of 2026 after rising towards the end of the previous year. The Consumer Price Index fell to around 3% in January, marking the lowest level since March 2025.

Part of this decline reflected seasonal factors, including lower airfares following the holiday period. At the same time, food and drink price increases slowed, helping reduce overall inflationary pressure. Core inflation, which excludes volatile items such as energy and food, dropped to around 3.1%, its lowest level since late 2021. Services inflation also edged lower, although it remains relatively elevated.

Many forecasters now expect inflation to continue declining towards the Bank of England’s 2% target during 2026.

Several developments may contribute to this downward trend. Changes to energy bill policies announced in the Autumn Budget are expected to reduce household energy costs, potentially lowering CPI by around 0.4 percentage points. In addition, the contribution from regulated and administered prices is expected to decline. Broader price pressures across goods and services may also moderate as the impact of last year’s national insurance increases fades.

Despite these encouraging signs, uncertainty remains. Inflation expectations are still relatively elevated, which could continue to place upward pressure on wages. Conversely, weaker economic demand or faster declines in food prices could lead inflation to fall below target.

Recent labour market data has been slightly weaker than expected. If this trend continues, the Bank of England may consider reducing interest rates in the coming months.

Productivity remains a long-term challenge

Recent data suggests that the UK continues to struggle with weak productivity growth, an issue that has persisted since the global financial crisis.

Preliminary estimates indicate that output per hour worked was around 0.5% lower in the final quarter of 2025 compared with the same period a year earlier. This suggests productivity performance remains below longer-term trends.

Sector-level analysis shows that productivity improvements since the pandemic have been concentrated in a relatively small number of industries. Information technology, manufacturing, and professional services have been the main contributors to productivity growth compared with pre-pandemic levels.

These sectors tend to share characteristics such as higher levels of capital investment, significant research and development activity, and stronger international exposure. By contrast, industries such as finance, insurance, and health and social care have made negative contributions to overall productivity trends.

While ongoing improvements to labour market data may lead to revisions in productivity estimates, the broader challenge facing the UK economy remains clear. Weak productivity growth continues to limit the economy’s long-term potential.

Both the Bank of England and the Office for Budget Responsibility expect some recovery in productivity in the coming years. Increased investment in technology, including artificial intelligence, together with lower borrowing costs could support productivity improvements. However, the pace of technological adoption and its impact on economic output remains uncertain.

Business investment remains cautious

Business investment continued to grow in 2025, marking the fifth consecutive year of expansion. However, the pattern of investment across sectors has been uneven.

Stronger investment activity has been concentrated in areas such as transport and logistics, information and communications technology, engineering, and vehicle manufacturing.

Despite these positive developments, survey data suggests businesses remain cautious about future investment plans. While the proportion of firms expecting to increase investment has remained slightly positive since the pandemic, many businesses continue to cite economic uncertainty, political developments, and cost pressures as factors limiting further expansion.

At the same time, lending data indicates a modest increase in borrowing by small and medium-sized enterprises over the past year, suggesting that some firms are gradually rebuilding confidence.

However, global developments remain an important consideration. Trade policy uncertainty, including ongoing developments around US tariffs, continues to present potential risks for international trade and business investment decisions.

Outlook

The latest economic data presents a mixed but stable picture of the UK economy. Growth remains modest, inflation is gradually easing, and the labour market is showing signs of cooling. These developments will play an important role in shaping expectations for monetary policy over the coming months.

If inflation continues to decline and labour market conditions soften further, the Bank of England may have greater scope to begin reducing interest rates later this year. At the same time, longer-term challenges, particularly weak productivity growth and cautious business investment, remain important issues for policymakers and businesses alike.