The Office for Budget Responsibility (OBR) has issued a stark warning regarding the potential ramifications of the ongoing conflict in Iran on the UK economy. As tensions escalate in the Middle East, the OBR cautioned that inflation forecasts have become increasingly unpredictable, particularly following recent spikes in gas and oil prices. These developments have led to revisions in the OBR’s economic projections, indicating a slower growth trajectory and a shifting unemployment outlook.
Rising Inflation Concerns
In its latest spring statement, the OBR highlighted that the conflict in the Middle East could have “very significant impacts” not only on the UK economy but also on the global economic landscape. The recent turmoil has created a backdrop of uncertainty, leading to an unexpected rise in energy prices that complicates the inflation outlook.
David Miles, a member of the OBR’s budget responsibility committee, remarked, “What will happen to inflation is particularly uncertain in the past few days.” The OBR had previously anticipated inflation would decrease towards the Bank of England’s 2% target early this year, but the recent volatility raises questions about that expectation.
The organisation has adjusted its inflation forecast for 2026 from 2.5% to 2.3% as a result of “greater slack in the economy” and declining food and energy prices. These adjustments may hint at a return to the target rate later this year, with the Bank of England suggesting inflation could dip below 2% as soon as April.
Adjusted Economic Growth and Unemployment Projections
In light of the current geopolitical situation, the OBR has downgraded its economic growth forecast for 2026, now predicting an increase of only 1.1%, down from a previous estimate of 1.4%. This revision reflects a slowdown in growth experienced in late 2022, coupled with a loosening labour market and subdued business data.
Chancellor Rachel Reeves addressed MPs, asserting that while growth may be slower initially, projections for subsequent years are more optimistic, with anticipated growth rates of 1.6% for both 2027 and 2028. However, the OBR also indicated that unemployment is expected to peak at approximately 5.33% in 2026, an increase from earlier predictions of 4.9%, before gradually decreasing in the following years.
The latest statistics from the Office for National Statistics (ONS) revealed that unemployment has already risen to a five-year high of 5.2% in the three months leading to December. The OBR now forecasts unemployment rates of 4.9% in 2027 and 4.4% in 2028, indicating a slight uptick in the jobless rate compared to previous estimates.
Government Borrowing and Fiscal Outlook
In a somewhat positive turn, the OBR has reduced its projections for government borrowing through to 2031, which could provide a financial cushion for the Chancellor. This improvement arises from easing yields on government bonds, allowing for an expanded fiscal headroom of £23.6 billion, up from £21.7 billion in November.
Elliott Jordan-Doak, a senior UK economist at Pantheon Macroeconomics, noted that the Chancellor’s recent budget was largely as expected, describing it as a “boring budget.” He acknowledged that many fiscal forecasts may now appear outdated due to the rapid developments in the Middle East.
Peter Arnold, chief economist at EY UK, added that the UK’s fiscal position has been bolstered by higher tax receipts, largely due to improved equity market performance since November. However, he warned that sustained stock market growth could be jeopardised if the conflict in Iran persists, leading to further global volatility.
Why it Matters
The unfolding situation in Iran poses a substantial risk to the UK economy, as rising energy prices and inflation uncertainty could dampen consumer confidence and economic growth. With the OBR’s revised forecasts signalling slower growth and higher unemployment, the government faces the challenge of navigating these turbulent waters. The potential for prolonged conflict in the Middle East could have far-reaching implications for the UK’s economic stability, affecting everything from inflation rates to employment levels and fiscal policy. As the situation develops, it will be crucial for policymakers to remain vigilant and responsive to the emerging economic landscape.
