UK faces biggest hit to growth from Iran war of major economies, IMF says

In its updated projections, the IMF slashed its estimate for UK economic growth this year to a mere 0.8%. This represents a significant downgrade from the 1.3% prediction made in January, just prior to the eruption of hostilities in the Gulf region. The half-percentage-point cut is notably the largest reduction among all advanced economies, placing the UK’s growth prospects squarely in the middle of its peers for the current year. This downward revision is attributed to a confluence of factors: the direct economic fallout from the war, the expectation of fewer interest rate cuts by central banks globally, and the anticipated persistence of elevated energy prices well into the next year.

The UK’s particular vulnerability, as highlighted by the Fund, stems from its status as a net importer of energy. This structural characteristic leaves the nation highly susceptible to rapid and substantial increases in global energy prices, which are a direct consequence of the conflict in a key oil-producing region like Iran. Disruptions to oil and gas supplies, heightened shipping costs, and a general surge in geopolitical risk premium translate directly into higher costs for households and businesses across the UK, impacting everything from fuel at the pump to utility bills and the cost of manufacturing.

Despite the immediate challenges, the IMF does project a degree of recovery for the UK economy in the subsequent year. For 2027, the Fund expects the UK to regain its position as the fastest-growing European economy within the smaller G7 group of advanced nations, albeit at a slightly tempered rate of 1.3%. This projected rebound offers a glimmer of hope amidst the current gloom, aligning with the government’s ambitious target to be the fastest-growing G7 economy by the end of the current parliamentary term. However, the path to achieving this, even at a slower pace, will be fraught with economic headwinds.

Compounding the growth concerns, the UK is also forecast to grapple with some of the highest inflation rates among the G7 countries. The IMF predicts an average inflation rate of 3.2% for the UK this year, followed by 2.4% in 2027. This places the UK alongside the United States in 2026 and Italy in 2027 for the unenviable distinction of joint-highest inflation within the group. The Fund anticipates a temporary acceleration of UK inflation towards 4% this year, largely driven by the surge in energy prices. However, it expects inflation to gradually recede, returning to the Bank of England’s target rate of 2% by the close of 2027. This anticipated moderation is contingent on the fading impact of high energy costs and a loosening labour market, which is expected to temper wage growth.

The prospect of persistent inflation also casts a shadow over monetary policy. With UK inflation at 3% in the year to February, above the Bank of England’s target, some analysts believe the central bank might be compelled to consider further interest rate hikes later in the year, despite the broader economic slowdown. However, the IMF’s outlook cautions central banks globally against premature or overly aggressive interest rate increases. Pierre-Olivier Gourinchas, the IMF’s chief economist, stated that "reacting strongly to flexible commodity prices, when supply constraints are present only in the related sectors, brings down inflation fast but risks a recession later." This highlights the delicate balancing act facing policymakers: taming inflation without inadvertently plunging economies into deeper downturns, particularly when the inflationary pressures are primarily supply-side driven due to external shocks.

Responding to the IMF’s bleak assessment, Chancellor Rachel Reeves acknowledged the gravity of the situation. "The war in Iran is not our war, but it will come at a cost to the UK. These are not costs I wanted, but they are costs we will have to respond to," she stated. Reeves asserted that the government entered the conflict in a stronger economic position due to previous stability-building measures, but conceded that "there is more to do." Her comments underscore the government’s recognition of the external shock while attempting to project an image of preparedness and ongoing commitment to fiscal prudence.

However, the opposition quickly seized on the IMF’s findings. Shadow Chancellor Sir Mel Stride launched a scathing critique, arguing that Reeves had "no one to blame but herself" for the magnitude of the IMF’s downgrade. Stride pointed to recent domestic policy decisions, such as increases to employers’ National Insurance contributions and business rates, as factors exacerbating the UK’s economic vulnerability even before the conflict. He contended that the government’s "plan" had failed, leaving the UK with the "highest inflation in the G7, with businesses closing and the cost of living skyrocketing."

Adding to the political pressure, Liberal Democrat Treasury spokesperson Daisy Cooper delivered a pointed attack, labelling the downgrade an "indictment of Trump’s idiotic war and all those who cheered it on – including Reform and the Conservatives." Cooper further challenged the Labour leadership, stating that Prime Minister Sir Keir Starmer’s "latest flurry of stern words directed at the US President are worthless if there is no plan to protect people from Trump’s economic vandalism." These comments reveal a deeper political layer, suggesting that the conflict’s origins and handling are perceived by some as rooted in specific US foreign policy decisions under a previous administration, with implications for UK domestic politics.

Amidst these economic forecasts and political recriminations, there have been renewed calls for government intervention to shield citizens from the rising cost of living. Measures such as cutting fuel duty to alleviate pump prices have been widely mooted. However, the IMF’s chief economist, Pierre-Olivier Gourinchas, urged countries, including the UK, to be "very cautious" about introducing extensive assistance programmes. He noted that despite government efforts to rebuild financial buffers, the war had significantly reduced the UK’s fiscal flexibility. "There isn’t really a lot of room to go and spend in order to support households and businesses," Gourinchas told the BBC, advising that any support measures should "stay within the envelope" of current government spending to avoid further straining public finances or exacerbating inflationary pressures.

The IMF’s forecast carries a "significant level of caution" due to the inherent uncertainty surrounding the events in the Gulf. Its projections are predicated on a relatively swift resolution to the conflict by the second half of the current year. This crucial assumption highlights the fragility of the outlook; a prolonged or escalating conflict could lead to far more severe economic consequences than currently anticipated. Before the war, the IMF had actually expected to upgrade global economic prospects, noting that previous trade tensions, such as US President Donald Trump’s tariffs, had been less damaging than feared, with China, Europe, and Canada simply diversifying trade to offset US declines. However, the current situation presents a much graver threat, with the IMF warning that "the global economy is threatened with being thrown off course."

The immediate economic impact of the conflict is already evident in the Gulf region itself, where the economies of several nations, including Iran, Iraq, Qatar, and Bahrain, are projected to contract this year. Looking ahead, the IMF also outlined "more severe scenarios" where the economic fallout intensifies. Should oil prices average $110 a barrel this year and $125 next year, accompanied by sustained rises in broader energy prices and interest rates, the global economy would face a "close call" with recession. Such a scenario would entail widespread economic contraction, significant job losses, and a dramatic slowdown in international trade and investment, underscoring the immense stakes of the current geopolitical climate. The UK, as the IMF has made clear, would be at the forefront of bearing the economic brunt of such an outcome.