The UK is bracing for a staggering £35 billion economic setback this year, alongside heightened risks of recession, as the ongoing conflict in Iran casts a long shadow over the nation’s financial landscape. The National Institute of Economic and Social Research (Niesr) has revised its growth forecasts downwards, reflecting the increased challenges facing the government of Keir Starmer.
Growth Projections Slashed
In a sobering assessment, Niesr has reduced its growth expectations for 2026 by 0.5 percentage points, now predicting a mere 0.9% increase, and for 2027, it has lowered its forecast by 0.3 percentage points to 1%. This adjustment highlights the significant strain the Middle Eastern conflict is placing on the UK economy, even under optimistic scenarios.
David Aikman, Niesr’s director, remarked, “This is a serious blow to the government’s mission to get the UK economy growing again.” He emphasised that the UK’s vulnerability to global energy market fluctuations has been starkly exposed by the Iran war. Households will likely face rising energy bills, squeezing their finances, while businesses struggle with increased operational costs.
Inflationary Pressures Mount
The thinktank cautioned that the economic fallout could be exacerbated if oil prices surge to $140 per barrel, a scenario Niesr deems “severe but plausible.” Currently, Brent crude is trading at around $111 per barrel. Should this occur, inflation could spike above 5%, prompting the Bank of England to potentially implement its largest single interest rate hike since Black Wednesday in 1992, with a possible increase of 1.5%.
Even under a more moderate outlook, Niesr anticipates the Bank will raise rates by a quarter point to 4% in July, as financial markets expect the central bank to maintain rates during its upcoming policy meeting.
Government’s Fiscal Challenges
The economic turmoil comes at a precarious time for the Labour Party as it approaches a challenging local election cycle. Niesr warns that the financial repercussions of the Iran conflict could inflate UK government borrowing by nearly £24 billion by the decade’s end, severely limiting Chancellor Rachel Reeves’s fiscal flexibility.
In response to the crisis, Reeves has indicated that “nothing is off the table” regarding targeted support for households affected by rising energy costs. She acknowledged the importance of precision in governmental aid, highlighting that previous blanket measures have led to unintended consequences, including higher inflation and interest rates.
Rising Borrowing Costs
The situation has also intensified the UK’s borrowing costs in global bond markets, with yields on 10-year government bonds climbing above 5%—the highest level since 1998. This trend raises concerns over the affordability of future government debt amid ongoing economic pressures.
Stephen Millard, Niesr’s deputy director, noted that assumptions about oil prices stabilising and declining to $65 per barrel over two years are becoming increasingly optimistic. “Things can be much worse,” he stated, emphasising the need for the Bank’s monetary policy committee to act decisively this year.
Why it Matters
The unfolding crisis underscores the intricate links between global events and the domestic economy. As the UK grapples with the implications of the Iran conflict, the potential for recession looms large, threatening the financial stability of households and businesses alike. The government faces the dual challenge of maintaining economic growth while also managing inflationary pressures and rising borrowing costs. The decisions made now will resonate through the economy for years to come, impacting everything from household budgets to public services.