The National Institute of Economic and Social Research (NIESR) has revised its growth forecasts for the UK, predicting a £35 billion economic downturn and an increased risk of recession this year, largely due to the ongoing conflict in the Middle East. The think tank has reduced its growth expectations for 2026 and 2027, highlighting the adverse impact of rising energy costs on households and businesses. Chancellor Rachel Reeves is weighing options for targeted support as inflationary pressures mount.
NIESR Downgrades Growth Projections
In its latest report, NIESR has downgraded its growth forecasts for the UK economy for 2026 by 0.5 percentage points, now projecting a modest growth of 0.9%. For 2027, the forecast has been reduced by 0.3 percentage points, bringing it to 1%. This adjustment reflects a broader trend of economic slowdown, exacerbated by the instability in the Middle East.
David Aikman, director of NIESR, expressed grave concerns about the government’s ability to stimulate economic growth in light of these developments. He stated, “The Middle East conflict has laid bare the fact that the UK remains highly exposed to global energy shocks. Even if hostilities ease rapidly, higher energy prices will leave households poorer and businesses grappling with increased costs.”
Rising Inflation and Interest Rate Pressures
NIESR’s report cautions that even under a favourable scenario, the UK economy will struggle to expand as anticipated. The think tank has warned of a scenario in which global oil prices could soar to $140 per barrel, potentially triggering an inflation spike above 5%. Such a scenario could compel the Bank of England to enact a significant interest rate hike of 1.5%, the largest single increase since 1992.
Currently, Brent crude oil is priced at $111 per barrel, suggesting that the risks of higher inflation are not merely hypothetical. Under its baseline scenario, NIESR expects the Bank of England to raise interest rates by a modest quarter point in July to 4%, although there is uncertainty surrounding this outlook.
Impact on Government Finances
The economic turmoil stemming from the Iran conflict could add nearly £24 billion to UK government borrowing by the decade’s end, effectively erasing Chancellor Reeves’s fiscal headroom. As Labour faces mounting pressure from within the party and the electorate ahead of local elections, this financial strain complicates the government’s economic strategy.
Stephen Millard, deputy director at NIESR, remarked, “The assumption that oil prices have peaked and will decline to $65 per barrel over the next two years seems increasingly optimistic. The Bank’s monetary policy committee will need to raise rates this year, and the Chancellor faces difficult decisions ahead.”
The Political Landscape
As the political climate shifts, speculation about potential leadership challenges for Keir Starmer is growing, particularly in light of disappointing electoral forecasts. The rising borrowing costs on global bond markets reflect growing investor unease, with yields on 10-year UK government bonds surpassing 5% for the first time in years.
In the House of Commons, Chancellor Reeves reiterated her commitment to targeted support, arguing against blanket measures that could exacerbate inflation. She pointed out the repercussions of previous untargeted government spending, which had cost over £100 billion and led to higher rates and taxes.
Why it Matters
The downgrade in growth forecasts and the looming threat of recession underscore the UK’s vulnerability to global economic shifts, particularly in energy markets. As households brace for increased costs and the government grapples with significant fiscal challenges, the potential for prolonged economic hardship looms large. The decisions made in the coming months will not only affect the immediate financial landscape but will also shape the future trajectory of the UK economy.
