Conflict in the Middle East makes official economic forecasts immediately out of date

The UK chancellor of the exchequer would not have wanted to deliver her spring statement against the background of a fresh threat to the world economy.

For while Rachel Reeves announced that she has the “right economic plan for the country” in a “yet more uncertain world”, the conflict in the Middle East will undoubtedly complicate the UK’s economic prospects. And the latest economic forecast by the independent Office for Budget Responsibility (OBR), to which she was responding, may already be out of date.

It was too late, for example, for the OBR calculations to include any potential shocks in the global supply chain, or a spike in energy prices that may result from the US-Israeli strikes on Iran. At a press conference after Reeves’ statement however, an OBR representative warned that it could have “a very significant impact”. And they added that even before the crisis unfolded, the UK had faced an unusually high degree of uncertainty.

But otherwise, the OBR report – little changed from the autumn – paints a mixed picture for the UK economy. Weaker economic and job growth is somewhat balanced by the prospects of lower inflation and lower interest rates.

The government’s future “headroom” (the space for extra spending later on) is only slightly better than previously thought. And the OBR says that by 2031, government debt will still be 95% of GDP. At the same press conference, it added that this high level of debt relative to other countries makes the UK more vulnerable to external risks.

But Reeves bullishly told MPs: “We beat the forecasts last year […] we will beat them again” adding that stronger government finances will allow the UK to weather the storm and keep to its current spending plans.

Yet the war could well affect those spending plans and the government’s hopes of tackling the high cost of living. Oil and gas prices are already soaring, and stock markets are falling. The OBR itself accepts that “significant risks, including from conflict in the Middle East”, can significantly change its projections.

For example, gas prices have already spiked after the major Middle East supplier Qatar closed its main refinery following Iranian attacks. The effective closure of the strait of Hormuz will threaten the huge flow of oil to major Asian economies such as China, Japan, Korea and Taiwan.

The UK government may have capped household gas prices, but a long-term wholesale gas price increase would boost inflation and reduce the chances of a further interest rate cut by the Bank of England.

And while the UK gets relatively little gas from the Middle East, gas and oil prices are set internationally. Europe is much more dependent on gas from that region, so the disruption of supply could threaten both higher inflation and lower growth in the UK’s largest export market.

It also could be an existential threat to the high-performing export economies of Asia, which are driving global growth.

A worldwide slowdown will have serious consequences for the UK economy as it is highly dependent on foreign trade. US president Donald Trump’s unhappiness with prime minister Keir Starmer’s conditional support for his war may threaten the restoration of the UK’s favourable tariff deal.

A weaker UK economy – which is already growing at only slightly more than 1% a year – would have major consequences for government spending, tax receipts and the government’s headroom. This could mean both lower tax revenues and increased borrowing, with the costs of financing the government’s huge debts rising, reversing recent falls.

This may all make it difficult for the government to contemplate any electorally beneficial tax cuts ahead of the 2029 general election. It may even have to extend the freeze on tax thresholds further, squeezing workers’ pay packets.

These negative developments come as the government also faces major additional pressures on spending – which it has tried to delay in the hope of a stronger balance sheet later on.

These include costly reforms to increase spending on students with special educational needs and disabilities, and plans to reduce student debt. Other major long-term challenges include providing social care for an ageing population, meeting ambitious housing targets (which are well behind schedule) and providing for cash-strapped local government.

Rising geopolitical tensions could also force the government to accelerate plans to boost UK defence spending from 2.5% to 3.5% of GDP, at a cost of around £40 billion. This could well mean tax rises or further cuts in other departments.

A short and decisive war could lessen all these pressures. But uncertainty in itself can inhibit investment and threaten the UK’s ability to tackle its long-term productivity problem – the key to raising living standards.

Steve Schifferes does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.