The Middle East energy shock could wipe around £35 billion from the UK economy over the next two years in a “best-case” scenario, an economic think tank has warned.
The National Institute of Economic and Social Research (Niesr) said that a more protracted crisis in the Middle East could see the UK enter a recession in the second half this year.
The group’s latest quarterly economic projections pointed to an increasingly gloomy outlook as the war between US-Israeli and Iranian forces weighs on economies globally, with the UK set for slower growth and rising inflation.
It indicated that the Bank of England’s committee rate-setters are likely to increase interest rates this summer as a result, with the potential for up to six more hikes in a more severe scenario.
On Thursday, the Bank’s Monetary Policy Committee will vote on whether to keep interest rates at their current level of 3.75%.
Niesr said it expects interest rates to be held at this meeting, but predicted they will be increased to 4% in July – staying at this level through the rest of the year.
However, it said a severe scenario, which would see further inflationary pressure from a continuing conflict, could result in rates rising as high as 5.25%.
In its best-case scenario which would include a resolution in the Middle East this year, the organisation still pointed towards a slowdown in economic growth to 0.9% for 2026, compared with 1.4% growth in 2025.
The group said growth is likely to improve marginally to 1% in 2027.
In its previous outlook, Niesr had predicted 1.4% growth this year and 1.3% growth in 2027.
Even with a swift resolution to the conflict, Niesr said the UK economy will be around £35 billion smaller in 2026 and 2027, casting uncertainty over the Chancellor’s ambitions to grow the UK economy.
However, Niesr’s deputy director for macroeconomics Stephen Millard said an adverse situation is likely to knock around 0.4 percentage points off growth over the next two years.
The forecasts also indicated that inflation, which lifted to 3.3% last month, will slow to 2.5%.
But it is then expected to shoot higher as higher energy prices drive further inflation, with it expected to peak at 4.1% in January next year.
Niesr said it expects inflation will not drop back to the Bank of England’s 2% target rate until 2028 as a result.
Inflation is set to surpass wage growth, which is predicted to slow to 3.3% next year, putting pressure of household finances.
Growth in real personal disposable income is forecast to slow to 1% in 2026 and 0.6% in 2027, with low-income households who spend a higher proportion of their income on energy being hit the hardest.
David Aikman, Niesr director, said: “This is a serious blow to the Government’s mission to get the UK economy growing again.
“The Middle East conflict has laid bare the fact that the UK remains highly exposed to global energy shocks.
“Even if hostilities ease rapidly, higher energy prices will leave households poorer, businesses facing higher costs, and the economy materially smaller than we expected only a few months ago.”
