Rising investment in artificial intelligence and defence is giving Britain's economy a lift, according to two closely watched reports published on Monday, even as households face higher prices and employers grow more cautious about hiring.

The latest projections from KPMG put UK GDP growth at 1.5 per cent in 2026, up from 1.2 per cent the previous year. That is slightly above the eurozone average of 1 per cent forecast for this year, down from 1.4 per cent last year.

At the same time, BDO's monthly output index, which tracks activity across services and manufacturing, reached its highest level in more than four years in October. The index climbed to 100.46, up from 97.37 in September, its highest reading since July 2022. Across BDO's indices, any figure above 95 is treated as positive.

Both reports point to the same drivers. Investment in AI, defence and infrastructure is doing more of the work in supporting growth, while household spending power is under pressure from the cost of living and worries about job security.

"Europe's economy has remained resilient, but the sources of that are changing. Higher prices and concerns about job security are making households more cautious, while investment in AI, defence and infrastructure is expected to play a greater role in supporting growth," said Yael Selfin, chief economist at KPMG UK.

Business confidence is improving too. BDO's optimism index rose to 94.73 in October, a level not seen since before the 2024 autumn budget, with manufacturing growth boosted by increased AI and defence-related orders.

Scott Knight, head of growth at BDO, said the government's "non-budget" last month and the "absence of any significant new costs" would be a relief for businesses. "For the first time in years, genuine growth seems to be on the table. The challenge for the government now is to turn this potential into reality," he said.

The picture is not uniformly bright. KPMG expects UK inflation to average 3.2 per cent this year before slowing to 3 per cent next year, but that forecast assumes energy costs gradually ease through 2027. The Bank of England has said it expects inflation to peak at nearly 5 per cent next year.

Selfin cautioned that the recovery remained "vulnerable to further energy price shocks" after the Iran war pushed up global oil and gas prices. She added that some of the buffers that helped households and governments absorb the initial disruption had already been drawn down, leaving less room to cushion another setback.

Price rises are already eroding household purchasing power, KPMG said, with food inflation in particular facing upward pressure into 2027 after droughts in Europe this summer and an expected "super" El Nino weather event that could affect crop yields.

There are also mixed signals from the jobs market. Official statistics showed unemployment fell by 0.1 percentage points to 4.7 per cent in the three months to August, while the number of payrolled employees for September rose by 13,000 to 30.3 million. But a separate BDO index measuring hiring intentions, headcount and labour demand stayed in negative territory last month, edging up just 0.02 points to 93.12, and it is expected to remain around that level for some time.

The findings present a complicated picture for Chancellor John Healey, whose autumn budget last month was widely seen as a prelude to more difficult decisions further ahead. Growth is returning, helped by AI and defence spending, but households are still feeling the squeeze and the recovery remains exposed to another energy shock.