Hopes for a reprieve from high borrowing costs have been dampened by the economic fallout from the escalating US-Israel-Iran conflict. The OBR has cautioned that the resulting energy price shock could push UK inflation back up to 3% by the end of the year. This development is a blow to the Treasury’s plans to stabilize the economy and provide relief to consumers.
Before the recent military action, headline inflation was trending downward from last year’s peak of 3.8%. However, the surge in energy costs—with gas prices leaping by 50%—has effectively stalled that progress. David Miles of the OBR described the impact as “material and significant,” noting that the fluid nature of the war makes it difficult to predict exactly how high prices will go.
The retail sector is already feeling the pinch, with fuel prices rising at their fastest rate since the 2022 energy crisis. Chancellor Rachel Reeves has scheduled meetings with petrol retailers to address reports of excessive pricing at the pumps. The government is particularly concerned about reports of petrol reaching 180p per litre in some regions, which they view as an exploitation of the current geopolitical instability.
Financial markets have reacted swiftly to the OBR’s warnings, with most analysts now predicting that the Bank of England will hold interest rates steady next week. The possibility of a rate hike has even entered the conversation among some City economists. Such a move would add further pressure to households already dealing with higher energy bills and fuel costs.
The long-term outlook depends on whether the conflict in the Middle East can be contained or if it evolves into a prolonged regional war. While the current price shocks are not yet on the scale of those seen following the invasion of Ukraine, they represent a significant threat to the UK’s recovery. The government’s ability to respond is limited by tight borrowing rules, leaving little room for a large-scale intervention.