The UK economy is facing a potential £35 billion hit this year and an increased risk of recession due to the global fallout from the Iran conflict, according to a new warning from the National Institute of Economic and Social Research.
The analysis highlights growing pressure on Prime Minister Keir Starmer and Chancellor Rachel Reeves as rising energy prices and inflation threaten to derail economic recovery plans.
Energy Price Surge Threatens Growth
The think tank said that even under a relatively optimistic scenario, the UK economy will grow more slowly this year and next as higher global energy costs weigh on households and businesses.
The conflict in the Middle East has exposed the UK’s vulnerability to external energy shocks, with oil and gas price increases feeding directly into household bills and business expenses.
Economists warn that higher costs will reduce consumer spending power, increase operational pressures on firms, and ultimately shrink overall economic output compared with earlier forecasts.
Inflation Spike Raises Risk of Recession
Under a more severe scenario, the think tank warned that global oil prices could rise to $140 per barrel, triggering a sharp inflation surge in the UK.
Such a development could push inflation above 5%, significantly higher than current expectations, and increase the likelihood of a recession in the second half of the year.
Brent crude has already been trading above $110 per barrel, underlining the sensitivity of the UK economy to global energy markets.
Interest Rate Hikes Expected as Pressures Mount
Rising inflation is expected to force the Bank of England to tighten monetary policy further, with interest rate increases likely in the coming months.
The think tank suggested that rates could rise to 4% in the near term under its baseline scenario, with the possibility of more aggressive increases if inflation accelerates.
In a worst-case scenario, policymakers could implement a large single rate hike, echoing historic interventions during periods of economic instability.
Public Finances Under Strain
The report also warned that the economic shock could significantly weaken the UK’s public finances, adding up to £24 billion to government borrowing by the end of the decade.
This would erode much of the fiscal headroom the government has set aside under its own budget rules, limiting its ability to respond to future crises.
Ministers are now considering targeted support measures to help households cope with rising costs, though broad financial assistance packages are seen as potentially inflationary.
Political Pressure Builds Ahead of Key Votes
The economic outlook comes at a sensitive political moment, with the government facing mounting pressure ahead of upcoming local elections.
Rising borrowing costs have added to concerns, with yields on UK government bonds climbing to their highest levels in years, reflecting investor unease about inflation and fiscal stability.
The chancellor has emphasised the need for carefully targeted interventions rather than large-scale spending programmes, arguing that previous broad support measures contributed to higher inflation and interest rates.
UK Exposure to Global Energy Shocks
The UK has long been exposed to fluctuations in global energy markets, despite efforts to increase renewable energy capacity and reduce reliance on fossil fuels.
Past crises, including the energy price spikes following the COVID-19 pandemic and geopolitical tensions, have highlighted the challenges of balancing energy security with economic stability.
Experts say the latest developments underscore the need for long-term strategies to improve energy resilience, diversify supply sources, and protect households from volatile global markets.
As the situation evolves, policymakers face difficult decisions on managing inflation, supporting economic growth and maintaining fiscal discipline in an increasingly uncertain global environment.