Budget Watchdog Issues Stark Warning Over Iran Conflict Impact
The UK economy faces potential "very significant" consequences from the escalating conflict in Iran, according to the government's official budget watchdog. The Office for Budget Responsibility (OBR) delivered this sobering assessment while presenting its latest economic projections alongside Chancellor Rachel Reeves' spring statement.
Inflation Outlook Becomes 'Particularly Uncertain'
The OBR highlighted that the outlook for inflation has become "particularly uncertain" following recent spikes in oil and gas prices triggered by Middle East hostilities. David Miles, from the OBR's budget responsibility committee, explained that while their central expectation had been for inflation to fall toward the Bank of England's 2% target early this year, recent developments have introduced significant uncertainty.
"Our central expectation had been that inflation would fall back towards the Bank of England's 2% target early this year and will be around that level at the end of the year," Miles stated. "There must be more uncertainty around that right now."
Revised Economic Forecasts Paint Mixed Picture
The budget watchdog presented a series of revised economic forecasts that reflect both current challenges and longer-term optimism. For 2026, the OBR trimmed its inflation projection to 2.3%, down from a previous forecast of 2.5%. This adjustment partly reflects "greater slack in the economy" and falling food and energy prices.
However, the OBR simultaneously downgraded its economic growth forecast for 2026 to just 1.1%, a reduction from the 1.4% predicted last November. This downgrade was attributed to a growth slowdown late last year, loosening in the labour market, and subdued data from recent business surveys.
Unemployment Projections Worsen
The employment outlook also darkened in the latest projections. The OBR now expects the UK unemployment rate to peak at approximately 5.33% in 2026, significantly higher than the previous forecast of 4.9%. This follows recent Office for National Statistics data showing unemployment had already risen to a five-year high of 5.2% in the three months to December.
Looking further ahead, the OBR projects unemployment will decrease to 4.9% in 2027 and 4.4% in 2028, though these figures still represent increases from previous forecasts of 4.6% and 4.3% respectively.
Middle East Volatility Threatens Economic Stability
The OBR explicitly warned that "conflict in the Middle East, which escalated as we were finalising this document, could have very significant impacts on the global and UK economies." The forecasts were prepared before recent days of intensified attacks between US-Israeli forces and Iran, adding an additional layer of uncertainty to all projections.
Peter Arnold, EY UK chief economist, commented on this vulnerability, noting: "There may now be doubts around how long this stock market performance can be sustained if the conflict in the Middle East is prolonged and global equity market volatility continues."
Some Positive Fiscal Developments
Amid the concerning forecasts, the OBR did identify some positive fiscal developments. Government borrowing projections have been reduced for each year until 2031, providing potential relief for the Chancellor. Reduced borrowing costs, linked to easing yields on Government bonds, have widened the Government's headroom to meet its fiscal rules to £23.6 billion, compared with £21.7 billion in November's budget.
The OBR also lifted its growth forecasts for both 2027 and 2028, projecting the economy will expand by 1.6% in both years. Additionally, the organisation indicated that inflation is expected to remain at the 2% target from 2027 onwards, assuming energy costs don't derail this trajectory.
Chancellor Responds to Economic Challenges
Chancellor Rachel Reeves addressed MPs in Parliament, acknowledging that the OBR expects the UK economy to grow more slowly than previously anticipated in 2026, though growth should accelerate in subsequent years. She maintained that she has the "right economic plan" for the UK and noted that unemployment is "set to peak later this year" before declining in following years.
Elliott Jordan-Doak, senior UK economist at Pantheon Macroeconomics, characterized the spring statement as delivering the "well-flagged 'boring budget' that we and the market were expecting," but added that "chunks of the fiscal forecasts now look dated because of the rapid escalation of events in the Middle East."
