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Economic update: Some reasons to be cheerful amid warnings on borrowing

Summer's lease hath all too short a date

Provisional estimates from the Met Office indicate the UK experienced its second warmest July and sixth warmest August on record in 2026.

The summer weather was partly credited with increased turnover in several business sectors in July and boosting retail sales in August. UK consumer confidence levels also grew steadily for several months and reached their highest rate in over two years in September.

In his first major speech as Chancellor on 7 September, John Healey spoke of the economy "turning a corner".

However, as summer turns to autumn, higher inflation, the prospect of future interest rate rises, and higher than expected borrowing figures provide a challenging economic backdrop for the Chancellor ahead of his first Budget next month.

Inflation up, rates on hold (for now)

Inflation, as measured by the annual change in the Consumer Prices Index (CPI), was 3.1% in Augst 2026, up from 2.9% in July. Goods prices rose by 2.7% in August, though the largest upward contributions came from petrol and diesel prices. Petrol prices increased by 20.2% in the year to August while diesel prices increased by 27.8%, as the conflict in the Middle East continued to disrupt oil supplies.

Despite the rise in inflation, the Bank of England Monetary Policy Committee (MPC) voted to leave the Bank Rate unchanged at 3.75% at its September meeting. This was the sixth consecutive meeting the MPC voted to leave the rate unchanged.

Inflation has now been above the Bank's 2% target for almost two years. MPC analysis estimates 0.7 percentage points of the 1.1 percentage point deviation from the 2% inflation target in August were "driven by the direct effects of energy prices, mostly motor fuels." 

Energy prices are expected to contribute to higher inflation in the coming months. Inflation is now predicted by the MPC to increase to around 3.75% in Q4 2026 and slightly above 4% in Q1 2027, though MPC members acknowledged the difficulty in assigning "any probability to future outcomes for energy prices with confidence given the unpredictable geopolitical environment."

Commenting on the decision to hold the Bank Rate, Bank of England Governor Andrew Bailey said the longer energy price volatility continues "the more likely it is we will need to raise the Bank Rate to ensure that inflation falls back to our 2% target."

Source: ONS series D7G7, Bank of England

Safe as houses?

While the base rate remained static, the cost of borrowing has increased, and mortgage approvals have fallen.

The average rate for a new two-year fixed-rate mortgage was 4.92% in August 2026, just under one percentage point higher than at the start of the year. Higher mortgage rates may be contributing to weaker demand from potential buyers. There were 54,918 mortgage approvals in August 2026, the lowest monthly level since December 2023, a fall of 2% compared to July and a fall of 16% compared to a year earlier.

Source: Bank of England series LPMVTVX and IUMTLMV

Confidence and retail therapy

Amid prices rises, retail sales increased in August, while the GfK Consumer Confidence Index, which measures UK consumers' confidence in their personal financial situation and the general economic situation, rose by four percentage points between July and September to the index's highest level since August 2024.

The total volume of retail sales increased by 0.5% in August compared to July, reaching their second highest level in over three years, and by 0.9% in the three months to August compared with the previous three months.

Feedback from retailers suggests sales were helped by warm weather, driving sales of clothing and household goods. Supermarkets also reported increased sales, also helped by warm weather and summer sales promotions.

MPC analysis concluded increased energy prices have yet to have significant impact on the price of consumer goods through increased supply chain costs, though judged these effects "were expected to build over the next few quarters."

High street versus forecourt

While retail sales increased overall, there was a noticeable drop in automative fuel sales, which fell by 1.3% in August compared to July and by 2.5% in the three months to August. Feedback from retailers suggests consumers have changed habits in response to fuel price increases, including making fewer journeys and only partly filling their tanks.

Source: Office for National Statistics (ONS), series L7RS, L7R4, J5EK, EAPT, JO5A

Warnings on borrowing costs

Public borrowing in the financial year to August was provisionally estimated to be £77.3 billion, £8.1 billion above the March Office for Budget Responsibility (OBR) forecast.

Interest paid on central government debt was £8.8 billion in August 2026, the highest August figure since monthly records began in 1997 (though these figures are not adjusted for inflation), but lower than in all the of first three months of the current financial year.

Analysis published by the Institute for Fiscal Studies (IFS) describes debt interest as comprising a "worryingly large share of overall government spending" which, combined with growing inflation, creates difficulties for the Chancellor "who is looking to bring down borrowing and to spend more on government priorities" in the forthcoming Budget.  

These figures come at the same as warnings from the Organisation for Economic Co-operation and Development (OECD) and the International Monetary Fund (IMF) on high levels of public debt across the world.

The OECD's September Economic Outlook, Interim Report warned that many countries face "pressing fiscal challenges" due to increased public borrowing costs, saying this underlined the need for governments to "strengthen revenues to ensure longer-term debt sustainability" and maintain the ability to "react to significant shocks".

In an interview with the BBC on 22 September, IMF Managing Director, Kristalina Georgieva, said governments had taken "no action" to service the cost of growing public debt, and must "bring debt levels down, put fiscal consolidation as a priority, and make sure that the central banks deliver on their mandate for price stability".