UK inflation and interest rates will fall by less than expected over the next two years after Rachel Reeves' budget delivered significant spending and borrowing.

The Organisation for Economic Co-operation and Development (OECD) said it now expects interest rates to drop to 3.5% by the start of 2026, down from currently 4.75%.

It also predicted headline inflation of 2.7% for 2025 after previously pointing towards a rate of 2.4% for the year.

Inflation is then expected to fall to 2.3% in 2026, but will still remain above the Bank of England’s 2% target.

In its annual economic survey, the OECD warned: “Persistent price pressures on the back of the strong increase in government expenditure and uncertainty about the degree of slack in the labour market could require the monetary stance to remain tighter for longer.

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“Wage-driven pressures on the price of services and the fiscal stimulus will keep underlying price pressures elevated”, which it said would leave inflation above the Bank of England’s 2% target for the next two years.

The Paris-based organisation predicted UK growth of 0.9% this year and 1.7% in 2025, up from 0.4% and 1% in May. However, it said this growth was largely driven by a “large increase in public expenditure” that would push up debt permanently.

Growth in 2026 is expected to slow to 1.3% while public debt is set to remain at 100% of GDP and rising further.

Meanwhile, the global economy is predicted to grow by 3.2% this year and 3.3% next year as lower inflation, job growth and interest rate cuts help offset fiscal tightening in some countries.

The figures are a slight improvement from the OECD's forecasts of 3.1% and 3.2% respectively in its September interim report.

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But the OECD also warned that benefit reforms were crucial to getting more people back to work as it highlighted that the post-pandemic contraction in the UK's labour force was more than that of any other OECD economy bar Costa Rica.

Chancellor Rachel Reeves said: “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. That is only the start. Growth only matters if it’s matched by more money in people’s pockets.

“That is why we protected people’s payslips from higher taxes at the budget and are determined to deliver growth that benefits households and improves living standards.

"This government will get our economy growing, with our National Wealth Fund, reforming the remits of our regulators and pension mega funds to attract better investment, as well as reforming our planning laws — all so that we can rebuild Britain for good.”

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