UK economy set to be hit hard by crisis in Middle East
The Organisation for Economic Co-operation and Development has warned that the UK could be the hardest hit among G20 economies by the war in Iran. Joe Nellis, economic adviser at professional services firm MHA, explains that the conflict underlines how vulnerable the country’s fiscal position remains to global shocks – especially those that drive energy prices higher.
The immediate risk is to growth. A spike in oil and gas prices would squeeze household incomes and raise costs for businesses. Consumers are likely to cut back, while firms delay or scale down investment, slowing activity across the economy.
Higher energy prices will push inflation back up, just as it appeared to be stabilising. This places the Bank of England in a difficult position: support growth and risk fuelling inflation; or keep interest rates higher for longer and deepen the slowdown.
Slower growth would weigh on tax revenues, while higher inflation would increase government spending through index-linked costs and debt interest payments. With borrowing already elevated and bond yields still close to record highs, the scope for fiscal flexibility becomes increasingly constrained.
The global economic shocks emerging from the war in Iran, and the resulting crisis in the strait of Hormuz, have shown the Chancellor’s house to be built on sand. The key question now is how the government will respond to weaker growth, higher inflation, and volatile financial markets, while protecting the most vulnerable from the most damaging effects of this crisis.
UK economy stalls in first quarter
The UK economy flatlined in January, signalling an underwhelming start to the year. But economic expectations have been thrown out the window by events in the Middle East, as threats of supply chain disruption and rising inflation rear their head again.
Growing inflation will not only hit consumers struggling from the cost-of-living crisis but also has the potential to seriously undermine the Government’s plan for growth. While previously we were expecting to see a number of interest rate cuts by the Bank of England across 2026, we must now face the possibility that rates may actually rise again. The Bank was criticised for acting too slowly as inflation climbed in late 2021 and 2022, so they will want to be on the front foot this time, acting sooner rather than later to curb unwanted price growth.
If the Bank holds interest rates for longer — or even raises them — tighter monetary conditions will dampen business investment and act as an obstacle to greater economic growth. Added to this, US tariffs on UK goods are expected to rise to 15%, up from the 10% that the UK Government had previously negotiated, creating further uncertainty and decreasing the competitiveness of UK exports.
Growth at its current pace will do little to transform the overall fiscal position. Public debt remains high and the Chancellor’s room for manoeuvre remains constrained. This has worrying implications for the struggling labour market. To stall and even reverse the rise in unemployment, the Government needs UK businesses to succeed, creating jobs as they expand.
This could all be an overreaction — the conflict in the Middle East could stabilise, oil and natural gas prices cool, and the Government can carry on trudging forward as planned. Yet downside risks have dramatically increased in the last two weeks, and the path to economic growth looks a lot more unclear than it previously did.
Since launching in 1869, MHA has become an international professional services provider of audit and assurance, tax, accountancy and advisory services, based in the UK with an international presence. Following the acquisition of Baker Tilly South-East Europe last year, the firm now employs nearly 2,200 people and has 153 partners across its network of 30 offices in the UK, Ireland, South-East Europe and the Cayman Islands.
