A leading think tank has warned that Britain faces an economic loss of £35 billion and the risk of recession this year as the fallout from the Iran war increases pressure on Keir Starmer’s government.
The National Institute of Economic and Social Research (Niesr) said that even in a best-case scenario, the UK economy would grow very slowly this year and next due to conflicts in the Middle East.
Households facing energy price rises linked to the Iran war, the chancellor, Rachel Reeves, have said are “nothing” as the government considers options to deliver a targeted and temporary aid package.
However, Britain’s oldest independent economic research body said the government faced a multibillion-pound hole in public finances amid a growing inflationary shock that would make it difficult for Reeves to respond.
David Ackman, director of Nasr, said: “This is a serious blow to the Government’s mission to get the UK economy going again.
“The conflict in the Middle East has exposed the fact that the UK is deeply affected by global energy shocks. Even if hostilities ease quickly, higher energy prices will cost households poorer, businesses more expensive, and the economy materially weaker than we expected a few months ago.”
In a pessimistic assessment of Britain’s prospects as war looms, Nasser slashed his previous growth forecasts to 0.5 percentage points for 2026, 0.9 percent, and 0.3 percentage points to 1 percent in 2027.
It also warned that under a downside scenario, in which global oil prices hit $140 a barrel, the UK would face a bigger inflationary shock than currently expected, threatening to push the economy into recession in the second half of this year. Brent crude was trading at $111 a barrel on Tuesday.
Calling it “severe but plausible”, he said such a scenario would risk UK inflation rising above 5%, which he said could force the Bank of England to raise interest rates in a single move – by 1.5% – the highest since Black Wednesday in 1992.
Even under its baseline scenario, based on a gradual cooling in global energy prices, it said it expected the Bank to raise interest rates by a quarter point to 4% in July, although it warned that a rise in borrowing costs could not be ruled out from Threadneedle Street at its next policy meeting on Thursday.
Financial markets widely expect the bank to leave interest rates unchanged on Thursday. City traders give an outside chance of a quarter-point increase. Last month, the bank kept rates at 3.75 percent.
With Labor under pressure in a tight round of local elections next week, Nasser said the economic fallout from the Iran war had the potential to add around £24 billion to Britain’s government debt by the end of the decade.
That would almost completely wipe out Reeves’ headroom against his self-imposed fiscal rules.
Stephen Millard, Nasser’s deputy director, said: “Things could have been a lot worse. In a way, the hypothesis [made by financial markets] Given that oil prices have more or less peaked and will hit $65 a barrel in the next two years, it looks increasingly optimistic.
“Either way [Bank’s] The Monetary Policy Committee will have to raise rates this year, and the Chancellor will have some very tough calls.
Britain’s borrowing costs have risen sharply on global bond markets, amid speculation that Starmer could face a leadership challenge after a disappointing set of elections, and as deflationary shocks emerged.
The yield on 10-year UK government bonds rose above 5% on Tuesday. The 30-year yield is also near the highest level since 1998.
Reeves told MPs in the Commons on Tuesday that he was focused on providing targeted support because blanket measures would be expensive and inflation threatened to rise further.
“While people are calling for urgent help, the impact of the previous government – untargeted support which cost a total of more than £100bn – means that interest rates, inflation and taxes have become higher than they need to be,” he said.
