UK Office for Budget Responsibility Warns: Iran Conflict May Deal a "Major Blow" to the UK Economy

Source: Jintou Data

On Tuesday, the UK’s official forecasting agency warned that the British economy could face a “very significant” blow from the Iran conflict. Although Chancellor Reeves pledged to deliver “stability,” this conflict threatens to disrupt her plans.

Amid market turmoil, the Office for Budget Responsibility (OBR) lowered its 2026 growth forecast for the UK to 1.1%, but also acknowledged that there is immense uncertainty in its projections. Reeves presented MPs with new official economic forecasts, but these were prepared before the Iran conflict erupted over the weekend—the conflict has triggered surging energy prices and disrupted global markets.

The OBR stated, “The escalation of the Middle East conflict as we finalized our report may have very significant impacts on the global and UK economy.” The regulator expects slower UK growth this year, but has raised 2027 and 2028 growth forecasts from 1.5% previously to 1.6%.

Reeves noted that the OBR expects inflation to fall more rapidly than was expected last autumn. She stated that the “headroom” built into her fiscal rules has grown from £21.7 billion after the November budget last year to £23.6 billion.

As rising energy prices prompted traders to scale back bets on Bank of England rate cuts, the yield on 10-year UK government bonds rose 0.09% to 4.47% on Tuesday. While Reeves spoke, the UK gilt market became a casualty of the global bond sell-off.

Based on levels implied by swap contracts, the chance of a 25-basis-point rate cut by the Bank of England at this month’s meeting has dropped from 90% last Friday to about 25%. Traders now expect only one rate cut by year-end, down from two expected last week. However, fund managers welcomed a government announcement: it will sell £252 billion in government bonds in the fiscal year ending March 2027, in line with investor expectations and lower than the £304 billion sold in the previous year.

These fluctuations reflect market concern over the UK being highly exposed to the risk of natural gas price surges, which threaten the Bank of England's efforts to restore inflation to the 2% target. Consumer price inflation was 3% in January.

The most direct impact of high energy prices on UK consumers is seen at petrol stations. A $10 per barrel increase in oil prices typically adds about 0.1% to CPI inflation within a few months. Since the frequency of electricity price adjustments affected by natural gas is far higher in the UK than the euro area average, the impact is often more severe than in other European countries when prices change.

In her economic statement, Reeves sought to project confidence and calm, saying she had set the “right” plan for the UK economy. She reiterated the word “stability,” but the Gulf region situation has put her strategy—a strategy based on expectations of falling inflation, lower interest rates, and rising living standards—at risk.

Reeves tried to turn her actions to strengthen public finances from last November into an advantage, arguing these decisions provided the foundation for the UK to withstand new turmoil. She said, “In a world that is becoming more uncertain, this government has the right economic plan for the country.”

She promised this was a modest spring forecast, with no new policies or tax changes. She said she would give a speech later this month on promoting growth, including plans for improving trade ties with the European Union.

However, on Tuesday the UK gilt market’s reaction to the Iran conflict was a reminder that Britain’s public finances are highly fragile, with about £100 billion a year going to pay government debt interest. Reeves issued a warning to critics on the Labour Party’s left to abandon ideas of loosening fiscal discipline through higher borrowing and spending.

The Chancellor also issued a veiled warning to her restless party—not to oust Starmer from the prime minister’s office. She said, “Political instability will endanger all the progress we have made.” During her roughly 25-minute speech, Reeves spent most of the time listing previous policies and attacking rivals like the Conservative Party. Shadow Chancellor Mel Stride quipped in response: “Is that it? She talks about stability—what planet does she live on?”

Reeves said she would meet with industries hardest hit by the Iran conflict in the coming days, including North Sea energy companies and the shipping industry.