The war in Iran and blockade of the Strait of Hormuz could cost the UK $35 billion in output over two years, push inflation above 4%, and force the Bank of England to raise interest rates, according to National Institute of Economic and Social Research (NIESR) modelling.
Two Scenarios
The baseline assumes fighting ends soon and crude oil drifts from $110 to $65 by next year’s close. Should conflict persist and oil spike to $140 levels last seen before the 2008 crash damage doubles to $68 billion, and the Bank may face its steepest emergency tightening since Black Wednesday in 1992.
NIESR cut its 2026 UK growth forecast to 0.9% from 1.4% pencilled in February. GDP expanded 0.5% in Q1 and tracks for 1% in the first half. Growth flatlines in the second half as fuel costs erode consumer spending power.
Rates and Bonds
Annual CPI inflation forecast to climb to 4.1% by early 2027. NIESR expects the Bank of England to lift Bank Rate to 4% in July, reversing market expectations of cuts toward 3%.
Ten-year gilt yields breached 5% Tuesday the highest borrowing costs since the financial crisis before settling at 5.03%. Gilts were the worst-performing major asset class, reflecting the UK’s structural exposure to imported energy.
Treasury Pressure
Higher inflation erodes departmental budget values by 4% by decade’s end unless topped up. Chancellor Rachel Reeves faces difficult choices at the autumn Budget. Tax increases likely back in conversation.
In the adverse scenario, inflation stays above 4%, more than double the Bank’s 2% target. The Monetary Policy Committee could raise borrowing costs by 1.5 percentage points rapidly. NIESR deputy director Stephen Millard called $140 oil “severe but plausible,” warning central banks must “respond big time.”
The MPC expected to hold Bank Rate at 3.75% at Thursday’s meeting while officials assess June energy price rises. The key concern: second-round effects from pay settlements embedding inflation in the system.