The ongoing turmoil in the Middle East, particularly the conflict involving Iran, has sent oil prices soaring, leaving the UK government grappling with significant fiscal challenges. Analysts from the National Institute of Economic and Social Research (NIESR) warn that Prime Minister Andy Burnham will face tough decisions in his upcoming budget as inflation continues to rise, driven by these soaring oil costs.
Oil Prices and Inflation: A Rising Tide
With oil prices recently breaching the $100-per-barrel mark and the Strait of Hormuz largely shut down since March, the UK economy is bracing for the impacts. The NIESR predicts inflation could hit 3.8% by early 2027, compelling Chancellor John Healey to find an additional £24 billion by the decade’s end to uphold essential public services and welfare payments.
The thinktank has significantly lowered its forecast for available budgetary funds, slashing the estimated spending headroom from over £7 billion to approximately £3 billion. This dramatic shift underscores the economic strain stemming from the ongoing conflict.
Economic Growth at Risk
NIESR’s assessment reveals a grim outlook for the UK’s economic growth, projecting a slowdown to just 1.1% this year and next. This downgrade translates to a staggering £28 billion in lost potential growth over the next two years compared to earlier forecasts. According to David Aikman, the institute’s director, Burnham inherits a “challenging inheritance,” with inflation eroding public spending and borrowing costs at their highest in the G7.
Aikman cautioned against the temptation to finance new initiatives through increased borrowing, arguing that this could lead to even greater financial strain in the future, particularly if further economic shocks occur.
Burnham’s Ambitious Plans
Since taking office last week, Prime Minister Burnham has outlined an ambitious agenda, including a pledge to enhance adult social care, with plans for an NHS-style system expected to cost £18.5 billion by 2035. Additionally, he aims to support the one million young people deemed not in education, employment, or training (NEETs) by expanding mental health services and revamping the education system.
However, NIESR warns that the government’s total debt, which nears £3 trillion—or 95% of the national income—could climb further if borrowing is used to finance these initiatives.
Preparing for Difficult Decisions
Stephen Millard, NIESR’s head of macroeconomic forecasting, acknowledged the surprising resilience of the UK economy in early 2026 but cautioned that a slowdown is imminent. Even with a potential resolution to the Middle East conflict, inflation is expected to persist, putting pressure on Burnham to make tough budgetary choices.
Millard advocates for prioritising tax reforms over increasing existing tax rates, suggesting the introduction of a land value tax to replace council tax and stamp duty. He also highlighted the need to phase out VAT exemptions and tackle tax avoidance by affluent individuals and corporations.
The NIESR forecasts that inflation will average 3.1% in 2026, peaking at 3.8% in February 2027, and it may take until early 2029 for inflation rates to return to the Bank of England’s target of 2%. Meanwhile, financial markets anticipate a steady interest rate before a potential hike to 4% later this year.
Why it Matters
As the UK navigates these turbulent economic waters, the ramifications of rising oil prices and ongoing inflation will reverberate across public services and household finances. Prime Minister Burnham’s ability to implement effective fiscal measures while managing a challenging economic landscape will be crucial in determining the nation’s recovery trajectory. The stakes are high, as the choices made now will shape the economic future for millions of Britons.
