PolicyEngine Macro
note · 25 July 2026 · inflation
CPI fell to 2.8%. The model does not think it stays there.
Headline inflation came in a tenth above our published forecast and well inside its uncertainty band. The more interesting number is the one four quarters out.
What happened
UK CPI inflation fell to 2.8% year-on-year in 2026Q2, the fourth consecutive quarterly fall from the 3.8% peak in 2025Q3:
| 2025Q3 | 2025Q4 | 2026Q1 | 2026Q2 |
|---|---|---|---|
| 3.8% | 3.4% | 3.1% | 2.8% |
Our published forecast, archived on 21 July from a 2026Q1 data edge, had a median of 2.68% with a 68% credible band of 2.24% to 3.16%. The outturn was 0.12pp above the median and inside the band. That is one observation and proves nothing on its own; it is recorded in the track record either way.
Why the disinflation may not continue
The same forecast round does not extrapolate the fall. Its median CPI path is roughly flat through the third quarter and then turns back up:
| Quarter | Median | 68% band |
|---|---|---|
| 2026Q3 | 2.71% | 1.95% – 3.45% |
| 2026Q4 | 3.12% | 2.09% – 4.14% |
| 2027Q1 | 3.12% | 1.88% – 4.49% |
Note how wide those bands are, and that they widen fast: by 2027Q1 the model does not distinguish 1.9% from 4.5%. The re-acceleration is the central case, not a confident call, and the honest reading is that the model sees no strong reason for inflation to keep falling from here rather than a strong reason for it to rise.
The growth side is the mirror image. Real GDP grew 0.91% year-on-year in 2026Q1, having slowed through 2025 from 1.82% in Q1 to 0.86% in Q4, and the model has it recovering to 1.7% by 2026Q4. Unemployment was 5.0% in 2026Q1, down from 5.2% in the previous quarter but still a full point above its 2025Q2 level.
Bank Rate has been 3.75% since 18 December 2025 — seven months on hold, after 150bp of cuts through 2024 and 2025. If the model's central path is realised, inflation is back above 3% by the turn of the year with growth recovering, which is not a configuration that argues for resuming cuts; the risk to the front end is that the easing cycle is finished rather than paused. The size of the bands is the caveat and it is a large one: the model's own 68% interval for 2026Q4 spans 2.09% to 4.14%, so this is a directional read on the central case, not a confident rate call.
What would change this view
- 2026Q2 GDP, due from the ONS in August. The model's median is 1.10% year-on-year; a materially weaker print would undercut the recovery half of the story and is the single most informative release for this view.
- A downside Q3 CPI print. The model's 68% band opens at 1.95%; an outturn near that floor would make the re-acceleration look like model inertia rather than signal.
- Anything on the fiscal side. This note is a pure forecast read — no policy change is assumed. The transmission from a fiscal announcement to the rate path is not yet modelled here.
Limitations, stated
- boe-svar is a replication of Brignone and Piffer (2025) with coefficients estimated on 1992Q1–2023Q2. Only the conditioning data edge moves between rounds, so post-2023 information does not enter the coefficients.
- The model forecasts CPI and GDP. It has no term structure, no exchange rate transmission channel exposed on this site, and no view on market pricing. The rate discussion above is an inference from the inflation and growth paths, not a modelled rate forecast.
- One scored forecast is not a track record. Treat the model's accuracy as unestablished and read the pseudo-out-of-sample evaluation, where it beats a drifting random walk on 4 of 8 variables at one quarter and 2 of 8 at eight.