BNP Paribas economists expect UK growth to slow to 0.7% in 2026 from 1.4% in 2025. Quarterly growth is forecast to run at about 0.1%, after a projected +0.4% q/q in Q1.
Inflation is projected to rise to 3.6% year-on-year, linked to the war in Iran. It is then expected to ease gradually to 3.3% year-on-year in 2027, staying above the Bank of England’s target.
Uk Growth And Inflation Outlook
Monetary policy is projected to tighten by 50 basis points in 2026 rather than move towards easing. Ten-year gilt yields are expected to stay elevated in 2026, then fall to 4.30% in 2027.
The yen and sterling are expected to stabilise against the US dollar in 2026 and 2027. Forecasts given are USD/JPY 160 and GBP/USD 1.35 by Q4 2026.
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We are seeing signs of a significant economic slowdown, with recent figures from the Office for National Statistics showing Q1 growth at a mere 0.2%. This weakness is happening alongside persistent inflation, which climbed to 3.5% in March, uncomfortably close to the 3.6% peak we anticipate. This combination suggests that derivative plays on UK assets should factor in a stagflationary environment.
Rates And Gilt Market Implications
Given these inflationary pressures, the market is no longer pricing in the rate cuts we saw being anticipated back in 2025. Instead, SONIA futures now fully reflect the expectation of at least two 25 basis point rate hikes from the Bank of England by year-end. Traders should consider positions like paying fixed on interest rate swaps to capitalize on this expected tightening cycle.
The outlook for UK government bonds suggests yields will remain high for the rest of the year. With the 10-year gilt yield currently trading around 4.6%, there appears to be limited room for a bond rally until the market starts to price in rate cuts for 2027. We believe strategies involving selling gilt futures on any strength could be effective in the coming weeks.
This combination of slowing economic activity and rising interest rates creates a challenging environment for UK equities. We’ve seen corporate profit warnings increase in the first quarter, a trend we expect to continue as higher borrowing costs impact margins. Therefore, buying put options on the FTSE 100 could serve as a valuable hedge or a speculative position against expected market weakness.
For the pound, we see a tug-of-war between a weak economy and a hawkish central bank. While the growth outlook is poor, the prospect of higher interest rates provides support, with our view targeting 1.35 for GBP/USD by the end of the year. This suggests that selling downside volatility through options strategies might be a prudent approach, as the currency may remain range-bound.
