The UK stock market outlook for 2026

An attractively valued FTSE 250 index has the chance to shine in 2026 as mid-cap stocks benefit from tailwinds including lower interest rates and an improved earnings outlook.

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The optimism, which follows a long period when UK equities have been low down on the global shopping list, comes amid hopes that the chancellor has done enough to break the country’s so-called gilt doom loop.

The Budget’s largely disinflationary policies provided some reassurance to financial markets and appear to have opened up a pathway for more interest rate cuts by the Bank of England, fuelling hopes that long-term gilt yields will stop rising after five years.

Broker Panmure Liberum said that this should help lower discount rates for future cash flows and reduce the cost of capital: “The result should be a further re-rating of UK stocks, but growth stocks should benefit more than value stocks. Switch to stocks with faster earnings growth.”

The FTSE 250 delivered robust growth in excess of 6% in the year but remains some way short of the all-time high of 24,250 set in September 2021.

Its performance has been in contrast to the best year since 2009 for the FTSE 100 index, fuelled by strong demand for lenders, defence and commodities-focused stocks.

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Panmure Liberum noted recently that the FTSE 250 is valued at about 12.4 times forward earnings, whereas the FTSE 100 is on 13.1 times and the S&P 500 index on 22.4 times after the blue-chip benchmarks set record highs during 2025.

It adds that the dividend yield in the FTSE 250 is 4.3%, which on this metric alone means the mid-cap index looks the cheapest in 23 years compared to the FTSE 100 at about 3.5%.

The UK-focused benchmark often flies under the radar for income investors, including the fact that the spread of top payers is much broader than in the top flight.

As Octopus Investments points out, the top 10 dividend payers account for more than half of the FTSE 100’s total dividend payout compared to 28% for the FTSE 250.

Rathbone UK Opportunities Fund I Acc fund expects to see small and mid-caps’ discounts close sharply in 2026, particularly as global investors may look to diversify away from US mega-cap concentration.

It adds that FTSE 250 has an abundance of high-quality businesses that investors most favour.

Fund manager Alexandra Jackson added in a recent report to clients: “UK equities are cheap compared to history and compared to their global peers. UK mid-caps are cheaper still (despite typically commanding a premium).”

She pointed out that falling borrowing costs tended to be very supportive of the performance of mid-cap stocks over larger ones.

For Sanford DeLand’s TM SDL UK Buffettology General Acc Fund, the kind of long duration quality equities in its portfolio has seen a substantial de-rating due in no small part by the rise in the UK’s long-dated gilt yield since 2021.

It told investors following the Budget: “Our firm belief is that this headwind has now run its course and going forwards it is more likely to be a tailwind for our way of investing.”

However, RBC Wealth Management has flagged the risk that an increasingly unpopular Labour government abandons fiscal discipline.

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Frédérique Carrier, its head of investment strategy, said: “If the government loosens its fiscal stance to spur growth —  and its approval rating — financial markets would likely turn jittery, in our view, especially as the UK relies heavily on foreign investors to finance its debt.”

Capital Economics also warns that the risks to its interest rate and gilt yield forecasts are skewed to the upside, particularly if Keir Starmer and Rachel Reeves are ousted from their jobs.

The consultancy added: “There are question marks over whether the chancellor’s plans to hike taxes and to reduce real terms day-to-day spending growth to zero in the 2029-30 election year materialise. And party politics may force the chancellor to raise public borrowing.”

A backdrop of weak economic growth and higher-for-longer interest rates failed to stop 2025’s strong performance by UK equities, although idiosyncratic drivers at a stock level were behind much of the UK market’s return.

UBS expects returns to broaden out as the economic outlook improves, although these gains are likely to lag the pace of earnings given the strong valuation re-rating that’s already taken place.

The bank said: “While we see UK equities as well supported and expect the economy and earnings to accelerate over the next 12 months, we favour opportunities in the region with higher exposure to structural growth trends or those more cyclically exposed to a pickup in economic activity, especially in goods/manufacturing.”

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Earnings have fallen around 15% over the past two years, but UBS is backing growth to improve in 2026 as US policy clarity, lower interest rates and an expected drop in energy prices begin to support end-demand.

It forecasts profits growth of 5% in 2026 and around 15% in 2027.

The bank holds a Neutral stance on UK equities, with a base case for the FTSE 100 index of 10,000 by the end of 2026. Its upside scenario highlights a year-end 10,800, dropping 7,200 under its most pessimistic forecast.

The outcome is likely to depend on continued confidence in richly-valued US equities and on commodity price trends given that this sector contributes around 25% of FTSE 100 earnings.

A reversal of recent pound strength could also support higher local currency returns, with 75-80% of FTSE 100 revenues generated outside the UK.

The bank added: “We favour structural and cyclical beneficiaries in the region. We continue to like the banking, industrials, IT, real estate and utilities sectors as beneficiaries of a combination of global secular changes, an improving cyclical outlook and supportive policy.”

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Invesco believes lower interest rates should help encourage reluctant households to start spending again, adding that UK households are sitting on savings equivalent to 14% of GDP and which could be deployed as they become more confident.

It said: “We see interesting opportunities in utilities and internationally orientated consumer staples, many of which are at attractive valuations compared to their overseas counterparts.

“Healthcare remains out of favour for many, so it’s an opportunity we want to take advantage of. While already performing strongly, domestic UK banks are still well placed to deliver strong returns.”