The UK economy faces slowing growth and higher inflation due to soaring energy prices linked to the Middle East conflict, according to the Office for Budget Responsibility (OBR). The OBR cut its growth forecast for next year from 1.6% to 1%, while inflation is projected to peak at 3.8% in 2027.
Rising energy costs are the primary risk to the UK economy in the near term, citing the first assessment from the Office for Budget Responsibility (OBR) since the conflict in the Middle East began. These costs are expected to stifle growth, drive up inflation, and lower living standards.
OBR cuts growth forecasts to 1% for next year
The OBR has sharply reduced its economic growth prediction for next year, dropping it from 1.6% to 1%. While the agency raised its growth forecast for the current year, it expects a significant slowdown before a rebound in subsequent years.
Chancellor John Healey described the current environment as “global economic storms” and stated that the nation faces “real challenges ahead.” Healey noted that current government policies are intended to provide “breathing space” for households.
Did you know? When economic growth slows, businesses typically invest less and create fewer jobs, which can lead to stagnant wages and reduced government tax revenue for public services.
Inflation peaks at 3.8% by 2027
Price increases are expected to accelerate as higher energy bills move through supply chains to the consumer. The OBR now forecasts that inflation will remain higher for longer than previously estimated, reaching a peak of 3.8% in 2027.
High global oil prices have already impacted fuel costs. Petrol is currently averaging nearly £1.73 per litre, while diesel is near £1.99. Because goods are transported by lorries and vans, these fuel costs often lead to higher prices for essential goods, including food.
Economists at Pantheon Macroeconomics characterized the government’s cost-of-living support as “small beer” when compared to the expected surge in inflation over the winter.
Interest rates may rise to 4.5%
The Bank of England is widely expected to raise interest rates next week in response to recent inflation. While rates currently stand at 3.75%, the OBR forecasts they could climb as high as 4.5% in the coming years.
This changes the outlook, as the OBR had previously forecast two interest rate cuts for this year. Higher rates increase the cost of borrowing for both households and the government.
📈@OBR_UK expects growth to slow significantly next year due to higher energy prices and interest rates.But by 2030-31 they expect the level of GDP to fully catch up with their expectations from March, as energy prices and inflation are forecast to fall back to pre-war levels. pic.twitter.com/0dbHfxa44V
— https://x.com/TheIFS/status/2115476358583451957
| Economic Metric | Current/Previous Forecast | New OBR Forecast |
|---|---|---|
| Next Year’s Growth | 1.6% | 1% |
| Interest Rates | 3.75% (Current) | Up to 4.5% |
| Inflation Peak | Lower (Previous) | 3.8% (by 2027) |
Energy bills erode household income and increase government debt
Real household disposable income is expected to dip next year as energy bills erode spending power. This impact is more severe for low-income households, as energy costs consume a larger portion of their monthly budgets.
David Miles of the OBR described the situation as a “pretty grim picture,” stating there has been “virtually no growth” for individuals since before the Covid pandemic and calling it a “dismal period in British economic history.”
The government’s financial position is also affected. Higher inflation increases the cost of welfare and pensions, and raises the cost of borrowing. Consequently, the OBR predicts that the total amount the government borrows will increase more than previously forecast.
Uncertainties regarding Middle East conflict
The OBR admitted “significant uncertainty” remains in these predictions because the situation in the Middle East is volatile. Changes in the conflict could alter inflation expectations.
One potential variable is US politics; Donald Trump has suggested the war will end following the mid-term elections next month.
Common questions about the UK economic forecast
When will inflation return to the Bank of England’s target?
Inflation is expected to average 3.4% next year before eventually falling to the 2% target toward the end of the decade.
How will higher interest rates affect the government?
Higher rates increase the cost of debt interest repayments, which the OBR predicts will increase the overall amount the government needs to borrow each year.
What is the specific impact on fuel prices?
Average prices have already reached almost £1.73 per litre for petrol and nearly £1.99 for diesel due to high global oil prices.
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