The UK economy is facing renewed pressure as the conflict involving the United States and Iran drives up energy prices, fuels inflation and threatens household living standards.
The latest forecasts from the Office for Budget Responsibility (OBR) warn that higher energy costs could weaken economic growth in the short term, push prices up further and leave many households struggling financially. Interest rates are also expected to rise, increasing the cost of borrowing for consumers, businesses and the government.
Chancellor John Healey acknowledged the challenges when presenting his Budget, saying the government’s measures were intended to give households some breathing space in the coming months. He described the situation as a series of global economic storms that the country must navigate rather than ignore.
The OBR’s first assessment of the UK economy since the conflict began identifies rising energy prices as one of the biggest immediate risks. Although the watchdog has slightly improved its forecast for economic growth this year, it has significantly downgraded its expectations for 2027.
The economy is now expected to grow by 1.2% in 2026, before slowing to 1% in 2027, down from the previous forecast of 1.6%. Growth is then projected to recover to 1.6% in 2028, rise to 1.8% in 2029 and ease to 1.7% in 2030 and 1.6% in 2031.
Economic growth generally encourages businesses to invest, expand their operations, create jobs and increase wages. It can also boost tax revenues, giving the government more resources to fund public services. Sluggish growth, by contrast, can make it harder for businesses, workers and the government to improve their financial positions.
Inflation is expected to remain a significant obstacle. The OBR forecasts that prices will rise faster than previously anticipated as increased energy costs spread through supply chains and eventually reach consumers, particularly in 2027.
Motorists are already feeling the effects of higher global oil prices. Average petrol prices have approached £1.73 per litre, while diesel has reached almost £1.99.
Expensive fuel can also raise the cost of transporting goods, including food and other everyday essentials. As businesses face higher operating expenses, they may pass some of those costs on to customers, putting additional pressure on household budgets.
The OBR now expects inflation to remain elevated for longer than previously forecast, reaching a peak of 3.8% in 2027. Economists at Pantheon Macroeconomics have questioned whether the government’s cost-of-living measures will be sufficient, describing them as limited compared with the inflationary pressures expected over the winter.
The outlook for living standards is similarly concerning. The OBR expects household living standards to decline next year as higher energy bills reduce the amount of money families have available to spend on other necessities.
Lower-income households are likely to face greater pressure because energy costs account for a larger proportion of their budgets. Even as real household disposable income is forecast to grow from 2027 onwards, the expected improvement is weaker than previously projected.
David Miles of the OBR described the outlook as grim, arguing that individuals have experienced virtually no growth in living standards since before the Covid-19 pandemic. He characterised the period as one of the most disappointing chapters in recent British economic history.
Inflation is expected to average 3.4% in 2027 before gradually declining towards the Bank of England’s 2% target later in the decade.
Higher inflation could also influence the Bank of England’s interest-rate decisions. The Bank is widely expected to raise rates in response to recent price increases. Rates currently stand at 3.75%, but the OBR believes they could reach 4.5% in the coming years. Its earlier forecasts had anticipated two interest-rate cuts this year.
Higher interest rates make loans, mortgages and other forms of borrowing more expensive, potentially putting further pressure on households and businesses. However, savers may benefit from improved returns on their deposits.
The government will also face higher costs. Inflation increases the expense of servicing public debt, while rising welfare and pension payments can add to government borrowing. The OBR expects borrowing to exceed its previous forecasts in every year covered by its latest projections, although borrowing as a proportion of the economy is still expected to decline over the next five years.
The forecasts remain subject to considerable uncertainty, particularly because the future course of the Middle East conflict is unclear. Any significant change in the conflict could alter energy prices, inflation and the wider economic outlook.
US President Donald Trump has suggested that the war could end after next month’s midterm elections. However, the OBR has warned that the rapidly changing situation makes its projections uncertain.
For the UK, the combination of slower growth, higher prices and potentially more expensive borrowing presents a difficult economic challenge. While the government’s Budget aims to ease some of the pressure on households, much will depend on how energy prices develop and whether inflation begins to fall as expected.
