The National Institute of Economic and Social Research (Niesr) has revised down its growth projections for the UK, citing significant economic challenges stemming from the ongoing conflict in Iran. The think tank now anticipates that the UK economy will expand by only 0.9% in 2026, down 0.5 percentage points from its previous estimate, and by 1% in 2027, a reduction of 0.3 percentage points.
Economic Impact of the Iran Conflict
Niesr’s assessment highlights that the fallout from the Iran war is expected to result in a staggering £35 billion economic impact this year, heightening the risk of recession. As energy costs surge due to the conflict, Chancellor Rachel Reeves has indicated that the government is exploring various options for a targeted support package to mitigate the financial strain on households.
This report underscores the precarious nature of the UK’s economic outlook, particularly as inflationary pressures mount. Niesr noted that even in an optimistic scenario, the economy would struggle to regain momentum in the immediate future.
Inflation and Interest Rates Under Pressure
The think tank’s analysis reveals that if global oil prices were to escalate to $140 per barrel, the UK could face an even more severe inflation crisis than currently anticipated. Such a scenario could push inflation rates above 5%, potentially prompting the Bank of England to implement its most substantial interest rate hike since Black Wednesday in 1992—an increase of 1.5%.
Currently, Brent crude oil is trading around $111 per barrel. Niesr projects that, under a baseline scenario where energy prices stabilise, the Bank of England may still raise rates by 0.25% in July, bringing them to 4%. However, the uncertainty surrounding the ongoing economic climate means that any increase cannot be ruled out at the upcoming meeting.
Political Implications and Future Projections
As Labour faces mounting pressure ahead of significant local elections, the economic repercussions of the Iran conflict threaten to add approximately £24 billion to UK government borrowing by the decade’s end. This would nearly erase Chancellor Reeves’s financial leeway under her fiscal rules.
Niesr Deputy Director Stephen Millard expressed concern that the assumption of stabilising oil prices may be overly optimistic, suggesting that the Bank of England’s monetary policy committee will inevitably have to raise interest rates this year. This scenario places further pressure on the government to navigate fiscal challenges while maintaining economic stability.
In the context of rising borrowing costs on global bond markets, the yield on 10-year UK government bonds has surpassed 5%, marking a significant increase in borrowing expenses for the government.
Government’s Response to Economic Strain
Amidst these challenges, Chancellor Reeves reaffirmed her commitment to targeted support measures, arguing that blanket relief strategies could exacerbate inflationary trends. She highlighted the lessons learned from previous administrations, where untargeted assistance resulted in increased interest rates and taxes.
Reeves stated, “While people are calling for immediate support, the impacts of the previous government – the untargeted support which cost over £100 billion in total – meant that interest rates, inflation, and taxes have ended up being higher than they needed to be.”
Why it Matters
The downgrading of the UK’s growth forecasts by Niesr serves as a stark reminder of the interconnectedness of global events and domestic economic health. As the government grapples with the implications of rising energy costs and inflation shocks, the potential for recession looms large. The choices made now will not only shape the immediate economic landscape but also have long-lasting effects on the UK’s fiscal resilience and the overall wellbeing of its citizens.
