UK faces £35bn hit and risk of recession this year over impact of Iran war, thinktank warns | Economics

Britain faces a £35bn economic hit and risk of recession this year as the fallout from the Iran war increases pressure on Keir Starmer’s government, a leading think tank has warned.

The National Institute for Economic and Social Research (Niesr) said that even in a best-case scenario, the UK economy will grow much more slowly this year and next due to conflicts in the Middle East.

As households face a rise in energy costs linked to the Iran war, chancellor Rachel Reeves said “nothing is off the table” as the government considers options to provide a targeted and temporary support package.

But Britain’s oldest independent economic research institute said the government faced a multibillion-pound hole in the public finances amid a worsening inflation shock, making it difficult for Reeves to respond.

Niesr director David Aikman said: “This is a serious blow to the government’s mission to re-grow the UK economy.

“The conflict in the Middle East has highlighted the fact that the UK is highly vulnerable to global energy shocks. Even if hostilities ease quickly, higher energy prices will leave households poorer, businesses facing higher costs and the economy materially smaller than we expected just a few months ago.”

In a negative assessment of Britain’s prospects as the war progressed, Niesr cut his previous growth forecasts for 2026 by 0.5 points to 0.9% and by 0.3 points to 1% for 2027.

He also warned that in the event of a negative scenario, such as the global oil price reaching $140 per barrel, the UK would face a much larger inflation shock than currently anticipated, which would risk plunging the economy into recession in the second half of this year. Brent crude oil was trading at $111 a barrel on Tuesday.

Describing this as “serious but reasonable”, the organization said that such a scenario would pose the risk of UK inflation rising above 5 percent, which could force the Bank of England to raise interest rates by at most 1.5 percent in a single move since Black Wednesday in 1992.

Even in the baseline scenario of a gradual decline in global energy prices, he expects the Bank to raise interest rates by a quarter point to 4% in July, he said, but warned a rise in borrowing costs from Threadneedle Street could not be ruled out at its next policy meeting on Thursday.

Financial markets generally expect the Bank to keep interest rates unchanged on Thursday. City investors are betting a quarter-point increase is more than likely. Last month the Bank kept interest rates steady at 3.75%.

With Labor under pressure ahead of next week’s tough local elections, Niesr said the economic blow from the Iran war had the potential to add almost £24bn to UK government borrowing by the end of the decade.

This would virtually eliminate Reeves’ freedom to act against his own self-imposed financial rules.

Stephen Millard, Niesr’s assistant manager, said: “Things could be much worse. In a way, that’s an assumption. [made by financial markets] It looks increasingly optimistic that oil prices have more or less peaked and will fall to $65 per barrel within the next two years.

“In both cases [Bank’s] “The monetary policy committee will have to raise interest rates this year and the chancellor will have some very tough calls.”

Britain’s borrowing costs in global bond markets have risen sharply as speculation that Starmer may face leadership trouble following a series of disappointing elections and an inflation shock emerges.

The yield (in effect the interest rate) on 10-year UK government bonds rose above 5% on Tuesday. The 30-year yield also approached the highest levels since 1998.

Reeves told MPs in the House of Commons on Tuesday that the focus was on providing targeted support as blanket measures would be costly and risk increasing inflation further.

“While people were calling for urgent support, the effects of the previous government – ​​untargeted support totaling over £100bn – meant that interest rates, inflation and taxes were higher than they should have been,” he said.