The National Institute of Economic and Social Research (Niesr) has revised its growth projections for the UK downwards, forecasting a modest expansion of 0.9% in 2026 and 1% in 2027. This adjustment, a decrease of 0.5 and 0.3 percentage points respectively, reflects the heightened economic pressures stemming from the ongoing conflict in the Middle East, which poses significant risks to the government and the broader economy.
Economic Fallout from the Iran War
The ongoing war in Iran is projected to inflict a £35 billion blow to the UK economy this year, heightening concerns of a potential recession. Niesr warns that even in a favourable scenario, the country’s economic growth will be dampened due to the ramifications of this conflict. The increase in energy costs, driven by instability in the Middle East, is expected to squeeze household budgets and elevate operational expenses for businesses.
Chancellor Rachel Reeves has acknowledged the gravity of the situation, indicating that “nothing is off the table” as her government contemplates a targeted and temporary support package. Nevertheless, the thinktank has highlighted a looming multibillion-pound deficit in public finances as inflationary pressures mount, complicating the government’s response.
Revised Growth Projections
In a sobering assessment, Niesr has downgraded its growth forecasts, reflecting the negative impact of external shocks on the UK economy. The organisation’s director, David Aikman, articulated the gravity of the situation: “This is a serious blow to the government’s mission to get the UK economy growing again.” He emphasised the country’s vulnerability to global energy price fluctuations, suggesting that even a swift de-escalation of hostilities in the region may not shield households and businesses from the repercussions of elevated costs.
Under a more pessimistic outlook, should global oil prices escalate to $140 per barrel, UK inflation could surge beyond 5%. This scenario could compel the Bank of England to execute its most substantial interest rate hike since Black Wednesday in 1992, with a potential increase of 1.5%. Currently, Brent crude is trading at approximately $111 per barrel.
Interest Rates and Fiscal Pressures
Even in a baseline scenario that anticipates a gradual easing of global energy prices, Niesr predicts that the Bank of England will likely raise interest rates by a quarter point in July, bringing the rate to 4%. However, analysts caution that a more immediate increase cannot be discounted, particularly as financial markets expect the Bank to maintain its current positions in the upcoming policy meeting.
The economic climate remains precarious, compounded by rising government borrowing costs. The yield on 10-year UK government bonds recently surged past 5%, signalling growing investor anxiety. Such conditions are further exacerbated by the impending local elections, which place additional pressure on the Labour government led by Keir Starmer.
Chancellor Reeves has stressed the need for targeted financial support, arguing against blanket measures that could exacerbate inflation. She pointed to the costly, untargeted support offered by the previous administration, which has left a legacy of higher inflation and interest rates.
Why it Matters
The revised economic outlook from Niesr underscores the fragility of the UK economy in the face of international conflicts and domestic policy challenges. With inflationary pressures mounting and growth prospects dimming, the government’s fiscal strategy will be tested as it seeks to balance immediate support for vulnerable households with the necessity of maintaining economic stability. The stakes are high, as missteps could lead to prolonged economic hardship, thus impacting public confidence and the political landscape.
