The United Kingdom is facing a severe economic blow from the ongoing conflict in Iran, with the National Institute of Economic and Social Research (NIESR) warning that the country could suffer a £35bn hit to its economy. The think tank has downgraded its growth forecast for 2026 to 0.9%, down from a previous estimate of 1.4%, and predicts only 1% growth in 2027. This comes as a major challenge for Chancellor Rachel Reeves, who is already grappling with limited fiscal headroom.
Recession Risks and Interest Rate Hikes
NIESR's analysis indicates that even under a relatively benign scenario where the conflict is resolved soon, the UK will narrowly avoid a recession. However, inflation is expected to exceed 4% by early 2027, prompting the Bank of England to raise interest rates by 25 basis points as early as July. In a more severe scenario where oil prices surge to $140 per barrel, the Bank would need to hike rates by 150 basis points, undoing six cuts since July 2024. This would push inflation above 5% in 2027 and erode Reeves' £23.6bn fiscal headroom, forcing tough choices on tax and spending.
Impact on Households and Businesses
Stephen Millard, NIESR's deputy director for Macroeconomics, stated that the renewed instability and subdued growth would force difficult decisions. Director David Aikman warned that the energy price shock would leave households poorer and businesses facing higher costs. The think tank also noted that lifting restrictions on North Sea oil and gas licenses would not provide short-term relief but could improve resilience to future shocks. Current carbon tax systems fail to address imported energy, and energy storage is identified as a key lesson from the war.
Long-Term Vulnerabilities
The report highlights that the UK economy is more vulnerable to shocks than France, Germany, or the US, due to weak growth since the 2008 financial crisis, recent inflation spikes, and policy failures. City AM's Shadow MPC members warned that long-term risks include reduced growth potential, higher fiscal risk premiums embedded in gilt yields, and poor policy choices. Economist Vicky Pryce noted that the UK entered this crisis with higher inflation and interest rates than peers, limiting room for intervention. Jack Meaning, chief UK economist at Barclays, pointed to the risk of inflation expectations becoming embedded, which could force the Bank to keep rates high, leading to higher unemployment and weaker growth.
