United Kingdom economic output rose 0.5% in February, beating expectations and prompting Deutsche Bank to lift its first-quarter 2026 growth forecast to 0.5%–0.6% quarter-on-quarter. The stronger start to the year comes just as higher energy prices begin to hit households and businesses, raising the risk of a sharp slowdown from the second quarter onward.
Broad-based rebound in early 2026
Deutsche Bank chief UK economist Sanjay Raja said the February expansion was driven by gains in services, oil-related activity and construction. The data follow a weak second half of 2025 and point to a short-lived rebound as both consumer and business spending picked up at the start of the year.
Revised figures for January also came in stronger than first estimated, suggesting momentum at the turn of the year was firmer than previously thought. Forecast models have been adjusted to show the UK entering the current period of higher energy costs from a stronger base than assumed.
Iran-linked energy shock threatens output
That support is now being tested by rising fuel and utility prices linked to disruptions in energy markets following developments in Iran. Pump prices are up more than 20% since the onset of the oil shock, and household dual fuel bills are expected to increase by a similar margin over the summer.
Higher energy costs are projected to squeeze household budgets, cutting into discretionary spending. Companies are expected to respond by delaying investment and hiring decisions while reining in wage growth, a combination that could drag on output through the second quarter and possibly beyond, offsetting much of the early-year gain.
Services activity slows sharply
More recent survey data already point to a rapid loss of momentum. The S&P Global UK services PMI dropped to 50.5 in March from 53.9 in February, its weakest reading in eleven months and only just above the 50 level that separates expansion from contraction.
The downturn was led by the first fall in new business orders since November 2025. Survey respondents frequently cited geopolitical tensions and higher uncertainty as weighing on client investment decisions and consumer spending plans.
Reflecting the deteriorating backdrop, the International Monetary Fund has cut its 2026 UK growth forecast to 0.8%, down from 1.3% in January. The 0.5 percentage point reduction is the sharpest downgrade among the G7 economies.
Confidence and spending under pressure
Household finances are showing mounting strain. The GfK consumer confidence index fell to -21 in March, its lowest level in nearly a year, as expectations for the general economic situation over the next 12 months weakened markedly.
Retail sales numbers highlight the uneven nature of spending. March sales rose 3.6% year-on-year, but much of the gain was driven by an early Easter, which pushed food sales up 6.8%. Non-food sales, a clearer gauge of discretionary outlays, increased just 0.9%, signalling growing caution among consumers.
Inflation path shifts and rate cuts fade
The inflation outlook has also shifted. Preliminary estimates from the Bank of England now put consumer price index inflation at between 3% and 3.5% in the second and third quarters of 2026, higher than anticipated earlier in the year.
This has overturned expectations for near-term interest rate cuts. Financial markets have largely removed the prospect of easing and are now focused on whether the Monetary Policy Committee will hold its benchmark rate at 3.75% or consider raising it to counter persistent price pressures when it meets on 30 April.
Implications for markets and trading strategy
For markets reliant on economic confidence and abundant capital, the combination of slowing growth and sticky inflation points to a more challenging environment. Assets that depend heavily on inflows of disposable income and strong trader sentiment now rest on a weaker foundation than only a few months ago.
In the weeks ahead, attention is likely to centre on incoming inflation releases and Bank of England communication. Any shift towards a more hawkish stance, emphasising inflation control over growth support, would signal tighter liquidity conditions and could amplify price swings in risk-sensitive assets.
Want macro context for these market moves? Explore how fiscal policy shapes economic growth and investor sentiment worldwide.
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