Market News

Britain is at risk of falling into recession this year if the war in Iran drags on, economists have warned.

Failure by the US and Iran to reach a ceasefire threatens to wipe as much as £68bn from the UK economy, according to the National Institute of Economic and Social Research (NIESR).

It warned that a lack of resolution to the conflict – forcing the Strait of Hormuz to remain closed – would cause joblessness in Britain to soar, with unemployment reaching 5.8pc, a rate not seen since 2014. Inflation will rise to 5pc, marking the fastest increase in consumer prices since 2023.

Oil prices would risk hitting $140 per barrel, from their current level of $112 per barrel, NIESR said.

It suggested borrowers would also be battered as the Bank of England would be forced to ramp interest rates back up to 5.25pc in order to bring inflation back down. This would match the peak borrowing cost reached in 2023 in the aftermath of the pandemic and Russia’s invasion of Ukraine.

Stephen Millard, NIESR’s deputy director, said: “If the adverse scenario were to happen, we think there would be a high likelihood of recession in the second half of the year.

“We are not expecting it under our central case [of a more rapid reopening of Hormuz], but if events in the Middle East continue as they have done, there is definitely a possibility.”

The warning comes just weeks after the International Monetary Fund said Britain was facing the biggest economic shock in the G7 this year. It cut its UK growth forecasts for this year and next, suggesting the impact of “higher energy prices” would linger.

Even if there is a quicker resolution to the war, NIESR said inflation would peak at more than 4pc – double the Bank of England’s 2pc target – while the economy would flatline for the second half of 2026. That would represent a £35bn blow to Britain’s economy compared with pre-war projections.

Peter Dixon, an economist at NIESR, said this was because “it would take time for oil markets to normalise”, adding: “The pressures on the market will ensure that oil remains elevated, energy prices will remain elevated, and as a consequence inflation will remain elevated for some time to come.”

Higher inflation leaves the Government’s spending plans under pressure, as rising prices will erode the value of the budgets allocated to departments.

Topping these up to enable Whitehall to continue with plans set out at last year’s spending review will cost around £15bn per year, rising to £23.5bn in 2029-30, NIESR estimated.

This would almost entirely wipe out Rachel Reeves’s £24bn of headroom against her borrowing rules, unless she increases taxes further or finds savings elsewhere in the Government’s spending plans.