The Middle East energy shock could cost the UK economy approximately £35 billion over the next two years, even under a best-case scenario, according to the National Institute of Economic and Social Research (Niesr). The think tank warned that a prolonged crisis might push the UK into a recession during the second half of this year.
Economic Projections Worsen
Niesr's latest quarterly economic forecasts paint an increasingly bleak picture as the conflict between US-Israeli and Iranian forces disrupts global markets. The UK is expected to experience slower growth and rising inflation. The Bank of England's Monetary Policy Committee (MPC) may need to raise interest rates this summer, potentially up to six times in a more severe scenario.
On Thursday, the MPC will vote on whether to maintain the current interest rate of 3.75%. Niesr expects rates to remain unchanged at this meeting but predicts an increase to 4% in July, with rates staying at that level for the rest of the year. However, in a severe scenario marked by persistent inflationary pressures from the ongoing conflict, rates could rise as high as 5.25%.
Growth and Inflation Outlook
Even with a swift resolution in the Middle East, Niesr forecasts a slowdown in economic growth to 0.9% for 2026, down from 1.4% in 2025. Growth is expected to improve only marginally to 1% in 2027. This is a significant downgrade from Niesr's previous predictions of 1.4% growth in 2026 and 1.3% in 2027.
Inflation, which rose to 3.3% last month, is projected to slow to 2.5% before surging again due to higher energy prices. It is expected to peak at 4.1% in January next year and may not return to the Bank of England's 2% target until 2028. Inflation is set to outpace wage growth, which is forecast to slow to 3.3% next year, squeezing household finances.
Impact on Households and Government
Growth in real personal disposable income is expected to slow to 1% in 2026 and 0.6% in 2027, with low-income households—who spend a larger proportion of their income on energy—hit hardest. Stephen Millard, Niesr's deputy director for macroeconomics, noted that an adverse scenario could reduce growth by about 0.4 percentage points over the next two years.
David Aikman, Niesr director, commented: "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."
The think tank's analysis casts uncertainty over the Chancellor's ambitions to expand the UK economy, as the energy crisis threatens to undermine growth prospects for years to come.
