OBR warns UK economy could face ‘very significant’ hit from Iran war

Britain’s economy could face a “very significant” hit from the war in Iran, the UK’s official forecaster warned on Tuesday, as the conflict threatened to derail chancellor Rachel Reeves’ promise to deliver “stability”.

Against a backdrop of market turmoil, the Office for Budget Responsibility downgraded Britain’s growth forecast to 1.1 per cent in 2026 but admitted that its projections were subject to huge uncertainty.

Reeves presented the new official economic forecasts to MPs as part of her Spring Statement. But the figures were prepared before the US-Israeli war in Iran started at the weekend, triggering a surge in energy prices and rattling global markets.

The OBR said: “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 fiscal watchdog expects slower growth this year but upgraded its forecasts for 2027 and 2028 to 1.6 per cent from 1.5 per cent.

Reeves said the OBR had projected inflation to fall faster than it had expected in the autumn. The chancellor said that the “headroom” she has built against her fiscal rules, which stood at £21.7bn following November’s Budget, had grown to £23.6bn.

The chancellor addressed MPs as the gilt market was hit hardest in a global bond sell-off, with the 10-year gilt yield surging by 0.17 percentage points to 4.54 per cent, as the rise in energy prices prompted traders to scale back bets on interest rate cuts from the Bank of England.

The chance of a quarter-point interest rate cut at the BoE’s meeting this month has fallen to about 20 per cent, from 90 per cent on Friday. Financial markets are no longer fully pricing in one cut by the end of the year, down from two reductions last week.

The movements reflect concern that the UK is heavily exposed to surging gas prices, which threaten to impede the BoE’s efforts to return inflation to its 2 per cent target. Consumer price inflation was 3 per cent in January.

The chancellor sought to project an image of confidence and calm in her big economic statement, telling MPs she had the “right” plan for the British economy and that she had brought order to the public finances.

She repeatedly used the word “stability”, but events in the Gulf have left her strategy — founded on hopes of falling inflation, lower interest rates, rising business confidence and improving living standards — in peril.

Reeves attempted to make a virtue of the fact that she reinforced the public finances in her last Budget in November and that her decisions had provided a bedrock for Britain to withstand the new turbulence.

“This government has the right economic plan for our country in a world that has become yet more uncertain,” Reeves said.

Reeves had promised a no-frills Spring Forecast, with no new policy or tax changes, focusing instead on what she believes are encouraging signs of revival in the British economy.

There were no fresh policies, although Reeves said she would make a speech this month on boosting growth, which would include plans to improve trade links with the EU. She said developing AI and spreading economic growth across the UK were the two other main themes.

Reeves’ decision in her November Budget to boost her headroom against her key fiscal rule to £21.7bn was intended to reassure bond markets and had helped to bring down government borrowing costs.

But the reaction of gilt markets on Tuesday to the war in Iran was a reminder of the vulnerability of the UK public finances, where around £100bn a year is spent on servicing government debt.