The National Institute of Economic and Social Research (Niesr) has revised its growth projections for the UK economy, indicating a significant slowdown due to the ongoing conflict in the Middle East. The thinktank’s latest report predicts a reduction of 0.5 percentage points in the growth forecast for 2026, now set at 0.9%, and a decrease of 0.3 percentage points for 2027, adjusting it to 1%. This grim outlook suggests that the UK may face a £35 billion economic impact this year, coupled with heightened risks of recession.
The Economic Toll of Geopolitical Unrest
Niesr has sounded the alarm over the economic repercussions of the Iran war, stating that even under the most optimistic scenarios, the UK economy is poised for sluggish growth. As households grapple with rising energy costs exacerbated by the conflict, Chancellor Rachel Reeves has acknowledged that “nothing is off the table” regarding potential government intervention to provide targeted support.
However, the situation is compounded by a looming shortfall in public finances, driven by an inflation surge that complicates any immediate fiscal response. David Aikman, Niesr’s director, emphasised the severity of the situation, noting that the UK remains vulnerable to global energy price shocks. “The Middle East conflict has laid bare the fact that the UK remains highly exposed,” he stated, warning that even a de-escalation of hostilities would not alleviate the financial strain on households and businesses.
Growth Projections and Inflation Risks
In its assessment, Niesr has downgraded its growth expectations for the next two years, reflecting a broader concern over inflationary pressures. The report highlights a potential scenario in which oil prices could soar to $140 per barrel, triggering an inflation spike that could push UK rates above 5%. Such a scenario would likely compel the Bank of England to implement aggressive interest rate hikes—potentially the largest single increase since 1992—further straining the economy.
Currently, Brent crude oil is trading around $111 per barrel, and even under more tempered assumptions about energy prices, Niesr anticipates that the Bank of England will raise rates by a quarter point in July, bringing the rate to 4%. Though financial markets expect the Bank to maintain its current rate during its upcoming policy meeting, there remains a slim chance of an increase.
Fiscal Challenges Ahead
As the Labour government faces mounting pressure ahead of crucial local elections, the economic fallout from the Iran war is expected to add nearly £24 billion to government borrowing by the decade’s end. Such a burden could severely limit Chancellor Reeves’s fiscal flexibility in adhering to her self-imposed constraints. Niesr deputy director Stephen Millard cautioned that prevailing assumptions among financial markets regarding oil prices may be overly optimistic, indicating the need for proactive monetary policy adjustments.
The UK’s borrowing costs in global bond markets have surged, with the yield on 10-year government bonds surpassing 5% and the 30-year yield nearing levels last seen in 1998. In light of these developments, Reeves has reiterated the importance of targeted support, arguing that blanket measures could exacerbate inflation and increase fiscal burdens.
Why it Matters
The downgrade in growth forecasts underscores the interconnectedness of geopolitical events and domestic economic health. As households and businesses brace for rising costs, the UK government must navigate a delicate balance between providing necessary support and maintaining fiscal discipline. With inflationary pressures mounting, the economic landscape is fraught with uncertainty, placing increased scrutiny on the Labour government’s ability to respond effectively to these challenges. The situation not only highlights the fragility of the UK’s economic recovery but also raises critical questions about long-term strategies for resilience in the face of global disruptions.
