UK growth outlook weakened as Middle East conflict drives energy and inflation risks

Rising energy prices linked to the US-Iran conflict have become the biggest near-term threat to the UK economy, the Office for Budget Responsibility said in its latest assessment. The OBR raised its growth forecast for the current year but cut its projection for next year from 1.6% to 1%. Growth is expected to recover in later years, although the watchdog stressed that its projections remain uncertain because the course of the Middle East conflict could change quickly.

Higher energy costs are expected to feed through supply chains and into consumer prices. The OBR forecasts that inflation will peak at 3.8% in 2027, while its estimate for average inflation next year is 3.4%. Inflation is then expected to move back towards the Bank of England’s 2% target towards the end of the decade.

Fuel prices are already reflecting higher global oil costs. Petrol was averaging almost £1.73 a litre and diesel close to £1.99, according to the BBC. More expensive fuel can raise transport costs for food and other goods as companies pass higher expenses on to consumers.

The pressure is expected to weigh on household living standards. Real household disposable income is forecast to fall next year as energy bills reduce spending power, with lower-income households likely to be hit harder because energy accounts for a larger share of their budgets. OBR official David Miles described the outlook as “pretty grim” and said there had been virtually no individual income growth since before the Covid pandemic.

Higher inflation could also affect interest rates. The Bank of England was widely expected to raise rates from their current level of 3.75%, while the OBR said rates could reach 4.5% in coming years. That would increase borrowing costs, although savers could receive better returns.

Government finances face additional strain from higher debt-interest payments, welfare and pension costs. Borrowing is expected to be higher each year than previously forecast, although it is projected to decline as a share of the economy over the next five years. Chancellor John Healey said the government’s measures were intended to provide households with “breathing space” during the coming months.

Economists at Pantheon Macroeconomics said the support was modest compared with the inflationary pressure expected over winter. The government is also developing the £4.7bn Your First Home scheme for 70,000 first-time buyers in England. The Guardian reported that eligible buyers of new-build homes could receive an interest-free government equity loan worth 20% of the purchase price for five years, with deposits starting at 2.5%.

Applications are scheduled to open in February 2027, subject to income and local price caps.