Signs of economic strain from the Iran war are now visible in Britain, even as officials caution it is premature to draw firm conclusions about the conflict's full impact. Recent official and private-sector assessments point to worsening near-term prospects: growth forecasts have been trimmed and inflation estimates raised, while household and business indicators are moving in an adverse direction.
The Organisation for Economic Co-operation and Development has cut Britain’s projected growth in 2026 by more than for any other major economy and simultaneously increased the country's inflation forecast by the largest margin. Those revisions present a stark challenge to the government’s central electoral promise to repair public finances and fund improved public services through stronger growth, and they complicate the Bank of England’s task of bringing high inflation down.
Gas exposure amplifies the shock
Britain’s particular reliance on gas for electricity production makes it especially sensitive to spikes in gas prices. Gas costs have almost doubled this month, a move that reverberates through the electricity market because gas often sets electricity prices in the UK - unlike countries that rely more on nuclear generation. The swift rise in gas prices has translated quickly into higher energy-related costs across the economy.
Survey data this week recorded the largest month-to-month increases in decades in both the public's inflation expectations and a manufacturers' input-cost gauge, alongside declines in consumer confidence. Consumers are already experiencing the early effects at the pumps, and the agricultural sector warns of food price increases from next month, beginning with crops grown in heated greenhouses such as tomatoes, cucumbers and peppers.
Retailers expect the conflict to raise their operating costs and force higher selling prices, while also weighing on demand. Clothing retailer Next has said a prolonged conflict could lift its selling prices by 2% in June and by as much as 10% later in the year. The Co-op described consumer confidence as "fragile." In housing markets, floating mortgage rates are climbing and lenders have withdrawn some fixed-rate products in anticipation of higher Bank of England policy rates.
Limited policy levers complicate the response
Economists warn that the UK has less scope to counter a sustained energy shock than in previous crises. Ross Walker, chief UK economist and head of global economics at NatWest Markets, said the government lacks room to borrow heavily to protect households without unsettling bond investors, and that underlying inflationary pressures are too elevated for the Bank of England to cut policy rates quickly even as unemployment rises. "We enter this crisis in a suboptimal position," Walker said. "Policy leeway looks very constrained."
Last week the Bank of England asserted it stands ready to act to prevent the energy price spike from turning into a prolonged inflation problem similar to the one that followed the surge in gas prices in 2022. Yet officials are warning against assuming the central bank will simply replay its approach from four years ago. Between 2021 and 2023 the Bank raised borrowing costs from near zero to a peak of 5.25% in about 18 months.
BoE officials argue that some factors reducing the risk of a broad-based inflationary pass-through are the weaker state of the economy today and that the recent gas price increase has been less extreme so far. As policymaker Megan Greene put it: "There's always a risk of fighting the last battle, but we're certainly doing what we can."
Others caution that memories of the steep inflation surge to above 11% in 2022 will make it politically and institutionally difficult for the Bank to remain passive. Stephen Millard, deputy director of the National Institute of Economic and Social Research, said: "I think almost certainly, it is going to have to respond."
Those deciding the path of interest rates face constraints. The Bank's benchmark lending rate is currently 3.75% and unemployment is at its highest level since the COVID pandemic. That combination reduces the scope for multiple large rate increases to counter a severe inflation breakout compared with four years ago. Market pricing has shifted sharply: investors are now fully pricing three quarter-point interest-rate hikes by the Bank this year, reversing expectations of two cuts that prevailed a month ago. By contrast, most economists polled expect the Bank to remain on hold in 2026.
Fiscal options are narrowly circumscribed
Finance minister Rachel Reeves faces similarly constrained choices. Her predecessors spent a combined 120 billion pounds to shield households from job losses during COVID and to soften the blow from the post-Ukraine energy price surge. Public debt, which stood at about 83% of GDP shortly before the pandemic, is now around 93%.
Reeves has said any consumer support would be directed at "those who need it most," mindful of investor concerns about the cost of another large-scale intervention. Analysts at Capital Economics estimate that baseline tax cuts and one-off payments under consideration might total about 24 billion pounds, which would be less than half the support measures deployed in 2022 and 2023.
Millard said there is limited scope for targeted help, but warned it must be carefully structured to preserve market confidence in public finances. "The key is she needs to make sure that the support she provides is targeted at those people that really need it," he said. "She's also got to also make sure that they don't endanger their fiscal rule, because if they do, then the markets I think would react quite badly."
Outlook and watchpoints
At present, the immediate effects are concentrated in energy-related channels and sentiment: higher gas-driven energy costs, rising input prices for manufacturers, weaker consumer confidence, and early signs of upward pressure on retail and food prices. Policymakers in both the Treasury and the Bank of England face constrained policy space relative to previous crises, complicating efforts to shield households while maintaining price stability and market confidence.
Key indicators to monitor in the near term include gas and wholesale electricity prices, consumer inflation expectations, manufacturers' input cost gauges, retail selling-price intentions, mortgage rate movements and any targeted fiscal measures from the government. How these variables evolve will shape whether the current strains remain sector-specific or spill over into broader inflation and growth dynamics.
Currency conversion used in some official commentary is $1 = 0.7511 pounds.