The National Institute of Economic and Social Research has warned that the Middle East energy shock could wipe around £35bn from the UK economy over the next two years, even if tensions ease relatively quickly.
In a stark assessment, the institute said a prolonged conflict risks tipping Britain into recession later this year, as the fallout from war between US-Israeli and Iranian forces feeds through into higher energy costs, weaker growth and renewed inflation pressures.
Under its central outlook, the UK economy is now expected to grow by just 0.9pc in 2026, down sharply from previous forecasts, with only a modest recovery to 1pc in 2027 — highlighting the lasting economic drag from the crisis.
Even in this “best-case” scenario, NIESR estimates the economy will be £35bn smaller than previously expected by 2026-27, dealing a blow to the Government’s growth ambitions.
A more severe scenario could prove significantly worse. The think tank warned that persistent energy price shocks could force the Bank of England to tighten monetary policy further, with interest rates potentially rising as high as 5.25pc.
For now, it expects policymakers to hold rates at 3.75pc at this week’s meeting before increasing them to around 4pc in the summer, where they are likely to remain through the rest of the year.
However, inflation — which recently climbed to 3.3pc — is forecast to rise again, peaking at 4.1pc early next year as higher energy costs filter through the economy.
Crucially, the institute does not expect inflation to return to the Bank’s 2pc target until 2028, suggesting a prolonged squeeze on households.
Wage growth is predicted to lag behind prices, with earnings expected to rise by around 3.3pc next year, leaving many families facing a fresh hit to real incomes.
Real disposable income growth is forecast to slow sharply, particularly impacting lower-income households that spend a greater share of their earnings on energy and essential goods.
Stephen Millard, NIESR’s deputy director for macroeconomics, said even a relatively contained crisis would shave around 0.4 percentage points off growth over the next two years.
The projections underline the UK’s vulnerability to global energy shocks, with the Middle East conflict now emerging as a major external risk to the economic outlook — threatening slower growth, higher inflation and tighter financial conditions in the years ahead.
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.”
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