A Reprieve, Not a Resolution

The International Monetary Fund (IMF) has given the UK economy some welcome news. On 13 October, it raised its forecast for UK growth in 2026 to 1.3%, up from 1.0% in July. The UK is now joint second-fastest growing in the G7, the group of seven large advanced economies, alongside Germany. The official figures point in the same direction, with second-quarter growth revised up to 0.5% by the Office for National Statistics (ONS).

Yet many households will struggle to recognise this picture in their own finances. Consumer prices were 3.1% higher in August than a year earlier, while the interest rate on ten-year government borrowing recently reached its highest level since 2007. The Chancellor, John Healey, will deliver his first Budget on 28 October with a financial cushion considerably smaller than it was in March. A stronger economy and a squeezed public purse can both be true at once, which is why the improvement needs careful reading. What has actually improved, and how much weight can that improvement bear?

The IMF attributed its upgrade largely to increased investment linked to artificial intelligence (AI), and the UK and Germany were among the few G7 economies to receive a higher forecast. In January, the IMF had also expected UK growth of 1.3% in 2026. The October figure therefore restores that earlier forecast after a downgrade in July, rather than taking the economy into territory previously thought out of reach. The outlook has improved, but the revision alone does not establish that the UK’s underlying growth performance has changed.

The official data provide a more detailed picture of the improvement. When the ONS revised its figures, second-quarter growth rose from 0.4% to 0.5%, following growth of 0.6% in the first quarter. Stronger services and business investment helped explain the revision. Business investment, which covers spending by companies on assets such as equipment and software, rose by 1.8% in the quarter and was 5.2% higher than a year earlier. The initial estimate had put annual growth at just 0.8%. The ONS attributed the revisions to annual improvements in how it measures the economy, meaning part of the good news reflects a more accurate picture of activity that had already taken place.

Whether this signals a lasting improvement in the UK’s capacity to grow is harder to establish. Investment has lagged for years, and ONS figures put total investment at 18.9% of national output in the first quarter, the lowest share in the G7. One strong quarter cannot close that gap, particularly when the latest upgrade is linked in part to a technology investment cycle. The IMF also expects growth to ease to 1.2% in 2027, as higher energy prices and interest rates weigh on activity. Stronger investment has helped lift the outlook, but the UK still has a substantial investment gap to close. It is too early to conclude that the recent improvement will translate into a sustained increase in economic growth.

Beating a forecast is a lower bar than delivering strong growth. Annual growth of 1.3% may sound respectable, but total output can rise simply because the population grows. The figure alone tells us little about whether the average person is becoming better off. Productivity, which measures how much the economy produces for each hour worked, is more revealing because sustained gains allow wages to rise without placing the same pressure on prices.

The Resolution Foundation, a think tank, estimates that output per hour in the second quarter remained around 5% below the path implied by the Office for Budget Responsibility’s final forecast before the pandemic. That shortfall represents a substantial loss of potential output and income. It helps explain why the UK can record positive growth while still struggling to deliver the improvements in living standards that households expect.

There are signs of progress. Using its preferred method, which draws on administrative data to estimate hours worked, the Resolution Foundation finds that productivity growth has picked up since late 2024. The ONS’s own early estimate puts output per hour 0.7% higher in the second quarter than a year earlier. Yet the composition of that improvement matters. The Foundation estimates that 77% of the recent pickup in measured productivity growth comes from slower growth in hours worked. When hours worked grow more slowly, output per hour can rise even without a comparable acceleration in total output. The improvement is encouraging, but it is too early to conclude that the economy has become materially more efficient.

For households, the more immediate question is whether stronger activity is translating into higher incomes. There is some encouraging evidence. Real household disposable income per head, which measures income after tax and adjusts for price changes, rose by 1.0% in the second quarter, following a fall of 0.8% in the first. That was the strongest quarterly increase since late 2024. Against this, average pay after inflation fell over 2025, and the latest inflation rate remains above the Bank of England’s 2% target. The IMF expects inflation to average 3.3% this year and 2.8% in 2027, with core inflation not returning to target until late next year. The next earnings and inflation releases, due on 20 and 21 October respectively, will help establish whether the improvement in household incomes is continuing.

The outlook for borrowing costs adds another uncertainty. Oil prices remain elevated, with Brent crude reaching $107 a barrel on 12 October. A Reuters poll of economists suggests the Bank of England may raise interest rates in November as it responds to persistent inflation. Higher rates would put pressure on some mortgage borrowers, particularly those on variable deals or coming to the end of a fixed-rate agreement, although savers could benefit from better returns. If inflation proves persistent, households may find that stronger growth offers less relief than the headline figures suggest.

Stronger growth helps the public finances. When people earn and spend more, the government collects more income tax and VAT, while debt becomes smaller relative to the size of the economy. But a stronger forecast does not automatically give the Chancellor more room to spend. Higher borrowing costs and rising inflation are putting pressure on the public finances at the same time. The fiscal rules and the trade-offs they create were explained in an earlier Fiscal Compass article on why the government cannot please everyone.

The pressure is visible in the bond market. Ten-year gilt yields reached 5.527% earlier this month, their highest level since 2007, before easing later in October. Higher yields increase the cost of new government borrowing and can also feed into mortgage rates. Although borrowing costs have eased from their recent peak, they remain high by the standards of the past two decades.

The more immediate problem is how much room the Chancellor has to absorb further economic shocks. Estimates of fiscal headroom, the margin by which the government’s plans meet its borrowing rules, vary. A Reuters poll put the median estimate at £10–12 billion, down from £23.6 billion in March, while the Institute for Fiscal Studies (IFS) outlined a plausible scenario of around £20 billion. The difference reflects uncertainty over how the Office for Budget Responsibility (OBR) will assess factors such as earnings, inflation and employment.

The size of that buffer is only part of the challenge. The IFS has warned that inflation is eroding the spending power of departmental budgets already agreed by the government, potentially forcing difficult decisions even if the fiscal rules are met. Fiscal restraint can help maintain confidence in the government’s plans, while higher taxes or constrained public services carry costs for households and the wider economy. Stronger growth offers some relief, but it does not remove these trade-offs. The Budget will show how the government intends to manage them.

The improved outlook deserves recognition. The IMF expects the UK to grow faster than most of its G7 peers in 2026, and household disposable income per head recorded a welcome quarterly increase. These developments give the Chancellor a stronger starting point than seemed likely a few months ago.

Even so, the evidence calls for measured expectations. The IMF expects growth to slow in 2027, the UK continues to face a substantial productivity shortfall, and the recent improvement in measured productivity needs to be interpreted carefully. A stronger forecast is helpful for the public finances, but it cannot by itself resolve the pressures on government spending or guarantee better living standards.

The earnings and inflation figures on 20 and 21 October will provide an early indication of whether households are seeing sustained improvements. The OBR’s forecast on 28 October will show how much room the Chancellor has to meet the government’s fiscal rules. Ultimately, the test is whether stronger output translates into lasting productivity gains and rising real incomes. Until that happens, better-than-expected growth will offer some relief without fundamentally changing the economic choices facing the government or the households it serves.

Productivity: How much output is produced for each hour worked. Sustained productivity growth is central to raising wages and living standards over time.

Real incomes: Earnings or household income after allowing for changes in prices. They indicate what people can actually buy, rather than the amount shown on a payslip.

Gilt yields: The return investors demand for lending to the UK government by buying its bonds. Higher yields increase the cost of government borrowing and can influence mortgage rates.

Fiscal headroom: The margin by which the government’s tax and spending plans meet its own borrowing rules. A larger margin offers more protection if economic forecasts worsen.

If you found this insightful, consider sharing with friends or colleagues. For weekly economics-led takes on markets, policy, and macro trends, subscribe to The Fiscal Compass.

Read every article from The Fiscal Compass, alongside our collection of free economics and personal finance tools on our website: thefiscalcompass.co.uk

Follow along on social media for concise updates throughout the week:

Instagram: @thefiscalcompassofficial

X: @FiscalCompass.

LinkedIn: Vinay Meisuria

1. International Monetary Fund, World Economic Outlook, October 2026. Growth projections and the global economic outlook.
2. Office for National Statistics, GDP quarterly national accounts, April to June 2026. Revised GDP growth and real household disposable income.
3. Office for National Statistics, Consumer price inflation, UK: August 2026. Latest available inflation data at the time of writing.
4. Resolution Foundation, The Macroeconomic Policy Outlook: Q3 2026. Productivity estimates and the longer-term productivity shortfall.
5. The Productivity Institute, Q2 2026: Signs of UK productivity growth amid measurement uncertainty. Alternative productivity measures and their limitations.
6. Reuters, UK’s Healey should rebuild fiscal headroom to about £15–16 billion, Reuters poll shows, 15 October 2026. Fiscal-headroom estimates and market expectations.
7. Institute for Fiscal Studies, Spending pressures, not fiscal ‘headroom’, are the Chancellor’s key Budget challenge, 12 October 2026. Inflation, departmental spending and fiscal headroom.
8. Reuters, UK 30-year gilt yields hit 28-year high in global selloff, 7 October 2026. Recent movements in UK government bond yields.
9. Office for National Statistics, Average weekly earnings in Great Britain: September 2026. Release calendar for the forthcoming earnings data.
10. Office for National Statistics, Consumer price inflation, UK: September 2026. Release calendar for the forthcoming inflation data.
11. Featured Image: https://www.rawpixel.com/image/3303393