Key Takeaways
- Slowing food price rises are expected to lower UK inflation in 2026.
- The UK unemployment rate is now above 5% and could rise to a 11-year high this year, economists say.
- Key UK defense stocks such as Rolls-Royce and BAE Systems have started 2026 strongly, building on an impressive 2025.
With 2026 now underway, UK investors will be keeping their eye on the key data metrics that will shape equity and bond markets and influence consumer and investor expectations across the year.
What Impact Will UK Food Prices Have on Inflation in 2026?
The cost of food and drink played a major role in the UK’s battle with inflation in 2025. While not the only reason for the inflationary spike last year—energy prices also rose significantly—food and drink prices had a significant impact on the rate of inflation. They are also a very visible indicator of rising living costs and can influence voter intentions in a year of local elections.
The last inflation reading of 2025, however, suggested the rate could be on its way down. For the 12 months to November CPIH, the ONS’ preferred measure of UK inflation, fell markedly to 3.5% from 3.8% the month before, largely driven by slowing food, beverage and tobacco prices, the UK Office for National Statistics said. UK inflation is now at its lowest level since March 2025.
As investors continue to monitor the situation and attempt to predict what the Bank of England will do with UK interest rates in 2026, food price inflation will play a key role in what’s to come. The next inflation reading, for December 2025, will be released on Jan. 20.
Will UK Unemployment Keep Rising in 2026?
The UK economy underwhelmed in 2025. We won’t know the figures for the full 2025 calendar year, which includes the fourth quarter, until the Office for National Statistics releases data in February. The latest data is for Q3 2025, when the economy grew by just 0.1%
One factor influencing this was the UK labor market. It contracted in 2025 as employers responded to higher National Insurance employer costs by putting the brakes on expansion and hiring plans. Between August and October last year, the UK unemployment rate rose to 5.1% from 5.0%. If the unemployment rate surpasses 5.5% in 2026, as some economists fear will happen, it will be at an 11-year high. Jan. 20 is next data point for the UK jobs market, showing the unemployment rate in the three months to the end of November. Wage growth is also being closely watched by the Bank of England, although this rise in wages is seen to be moderating as the jobs market slows.
Why UK Defense Stocks Could Lead Markets in 2026
The extraordinary performance of defense stocks was a phenomenon in 2025 that played out globally. London-listed multinational aerospace and defense giant Rolls-Royce Holdings RR. stock rose 104% over the year while BAE Systems BA. climbed 52.12%. Both helped the FTSE 100 achieve its best year since 2009. These stocks were major contributors to performance of the Morningstar Developed Europe Aerospace & Defense Index which rose 50.63% over the year. Already in 2026, the index is off to a flying start, with a 13.68% uplift through Jan. 9, 2026 in euros, marking its best start to the year since inception.
Shares in Rolls-Royce, the biggest stock in the index and the fourth largest UK company, are up nearly 12% so far this year. BAE Systems shares are already up more than 20% in 2026.
This sector is extremely sensitive to the news cycle, so there may well be some volatility ahead.
Will UK Government Borrowing Rise in 2026?
Government borrowing plugs the gap between total public sector spending and income from taxation. In 2025, fears that the chancellor would have to raise taxes to meet the government’s self-imposed fiscal rules were realized. Uncertainty over this situation helped push the risk premium on owning UK government bonds or “gilts” higher as fear set in and demand fell.
With the economy underperforming and talk of a leadership coup in Westminster already in the offing in 2026, there’s no doubt the prime minister and his chancellor, Rachel Reeves, will be keen to see government borrowing fall ahead of May’s crucial local elections. In documents released alongside the tax-raising Autumn Budget in November last year, the Office For Budget Responsibility said government borrowing will fall to £138 billion in the 2025-26 tax year and will reach £67 billion by 2030-31. If the government can make this projection a reality, UK gilt yields may well have a less volatile time in the coming months and years.
Nick Ridpath, research economist at the Institute for Fiscal Studies, said last year that official forecasts on government borrowing are to be taken lightly: “Forecasts for the level of borrowing this year are subject to considerable uncertainty, never mind those for borrowing in four or five years’ time.”
Will GBP Fall Against USD in 2026?
The UK FTSE 100 repeatedly broke records in 2025, taking just days thereafter to close above 10,000 points for the first time ever. That came despite a number of headwinds, including international uncertainty over tariffs and the relative strength of the pound against a falling dollar. In 2026, investors are watching GBP closely, and it already appears sterling is losing ground against USD. Away from international uncertainty, it could be domestic events that cause volatility in the medium-term.
A change in leadership at the top of the UK government would undoubtedly weaken the pound, while a weaker labor market could lower the case for capital investment in the UK, weakening GBP further. Much also depends on the trajectory of interest rates: The Bank of England is expected by economists to cut rates one or two times in 2026, but futures markets don’t support that argument yet.
