In a stark warning for Britain, Allianz Trade has forecasted a significant slowdown in economic growth, predicting it will drop to just 0.9% by 2026. This follows a stronger-than-expected growth of 1.4% in 2025, which surprised many analysts. According to GBNews, the anticipated deceleration represents one of the sharpest declines among major global economies.
The projection highlights concerns over persistent inflation and tightening fiscal policies, which could lead to a period of economic stagnation. As the UK faces a challenging economic environment, the country may enter what economists are calling a “mild stagflationary phase,” a combination of sluggish growth and high inflation.
The Stagflationary Phase: What Does It Mean for the UK?
Stagflation is a challenging economic environment where inflation remains high while economic growth slows. The UK is facing this dual challenge, with inflation projected to stay above 3% until at least 2026, preventing the Bank of England from making significant rate cuts in the near future.
As inflation continues to outpace growth, the Bank of England may be forced to keep interest rates high, leading to a difficult borrowing and investment climate.
Maxime Darmet, senior economist at Allianz Trade, explains:
“The UK economy has delivered a positive surprise in the first half of 2025, with momentum still holding up. However, 2026 will bring tougher challenges. Inflation remains stubbornly high, forcing the Bank of England to pause rate cuts for an extended period.”
The report highlights that the UK will face a longer battle to bring inflation under control compared to the Eurozone, where inflation has already stabilized closer to the European Central Bank’s target since mid-2025. In contrast, inflation in the UK will only gradually ease, not reaching the 2% target until spring 2027.
The government’s fiscal policy will also play a significant role in shaping the economy. With the Treasury examining ways to raise revenue, the possibility of a VAT increase is on the table. While politically sensitive, Maxime Darmet points out that
“VAT, while politically sensitive, is among the least damaging taxes for growth and can raise significant revenue quickly—unlike higher corporate or national insurance contributions, which risk choking economic momentum.”
Inflation and the Bank of England’s Dilemma
Inflation continues to be a pressing issue for the UK. According to Allianz Trade’s report, inflation is expected to remain above 3% until 2026, forcing the Bank of England to maintain its restrictive monetary policy. This prolonged period of high inflation is expected to weigh heavily on households, as the cost of living remains elevated.
For example, household disposable income per head grew only 0.2% in the second quarter of 2025, following a decline of 0.9% earlier in the year. Families are increasingly feeling the pressure, leading to a rise in the household saving ratio, which reached 10.7% in the second quarter—indicating that people are becoming more cautious with their spending.
The UK’s struggle with inflation stands in stark contrast to the Eurozone, where inflation has already been brought under control. This delay in addressing price pressures has significant implications for both businesses and households, as the continued high cost of goods and services will limit consumer purchasing power and dampen overall economic demand.
The Government’s Response: VAT Increases and Budget Cuts
With the economic outlook growing increasingly uncertain, the UK government is exploring ways to generate additional revenue, including the possibility of raising VAT. While this move could generate much-needed funds, it is not without risks. As Darmet notes,
“The Government’s forthcoming fiscal measures will intensify the economic headwinds, with spending cuts and potential tax rises set to dampen domestic demand throughout 2026.”
As the government struggles with its deficit, spending cuts and potential tax increases are expected to slow domestic demand even further.
In addition to the VAT increase, the government may look to implement other fiscal measures, which could weigh heavily on growth. Darmet suggests that while raising VAT is politically difficult, it remains one of the least damaging tax hikes in terms of its effect on growth.
This contrasts with more drastic measures, such as increasing corporate taxes or national insurance contributions, which could have a more significant adverse effect on economic momentum.
