NIESR Warns Iran War Could Erase £35bn From UK Economy

What NIESR's scenarios actually say

NIESR's central projection now puts UK GDP growth at 0.9 per cent for 2026, down from 1.4 per cent in the think tank's previous forecast, according to the report. Growth in 2027 is expected to slow further to just one per cent. The revision amounts to a hit of at least 0.5 percentage points this year attributable directly to the Iran war.

The think tank describes its central case as "relatively benign," assuming the Middle East conflict is resolved within days. Even under that assumption, the economy narrowly avoids a technical recession and the Bank of England raises rates by 25 basis points.

The stress scenario is considerably darker. If Brent crude surges to $140 per barrel, NIESR projects the UK economy would be at least £35bn smaller than it would have been without the war, according to the institute's director David Aikman. In that case, the Monetary Policy Committee would need to raise rates by 150 basis points, unwinding a string of six cuts delivered since July 2024.

NIESR acknowledged that such tightening would likely be gradual, meaning inflation would still exceed five per cent in 2027 even with higher rates. Under the central scenario, inflation is forecast to breach four per cent by early next year.

The interest-rate and inflation bind

The Bank of England faces what Stephen Millard, deputy director for macroeconomics at NIESR, described as a "renewed period of instability and subdued growth" that will force difficult choices on Threadneedle Street.

The dilemma is familiar but acute. Raising rates to contain inflation risks deepening a slowdown already visible in the growth numbers. Holding rates risks allowing inflation expectations to become entrenched.

Jack Meaning, chief UK economist at Barclays, responding independently of the bank, framed the tension directly in comments reported by City AM:

"The most worrying scenario is that, in order to achieve its inflation target in a credible way, the Bank of England may have to set rates in a way that comes at the cost of higher unemployment and weaker growth."

Meaning noted the two opposing risks are "pretty balanced": on one side, expectations of higher inflation becoming embedded; on the other, the price shock proving short-lived and revealing a weak economy weighed down by rates kept too high.

The UK entered this crisis in a comparatively weak position. Economist Vicky Pryce, a member of City AM's Shadow MPC, noted that Britain had "higher inflation and higher interest rates than other comparable countries" such as France, Germany and the United States at the onset of the conflict, "and with more limited room for intervention, so the long-term impact is likely to be greater than elsewhere," according to her comments reported by City AM.

For businesses carrying variable-rate debt or approaching refinancing windows, the practical implication is stark. The cost of borrowing, which had been on a downward trajectory since mid-2024, could reverse sharply. A 150-basis-point increase in the stress scenario would add material weight to interest payments across leveraged balance sheets, from commercial property to growth-stage equity.

Fiscal headroom: from thin to non-existent

The Office for Budget Responsibility estimated the Chancellor's fiscal headroom at £23.6bn in its March 2026 forecast. That figure was already considered thin by historical standards. NIESR's analysis suggests it could all but evaporate.

The mechanism is straightforward. Lower growth means lower tax receipts. Higher gilt yields, driven by inflation expectations and a possible fiscal risk premium, raise the cost of servicing government debt. NIESR's report states that if the government wishes to maintain real-terms increases in expenditure until 2030, the headroom disappears under the stress scenario.

The think tank labelled the Chancellor's current tax and spending plans "untenable" even under the more benign central case, according to the report. That language carries weight. It implies that further fiscal adjustment, whether through tax rises, spending restraint, or both, is probable regardless of how the conflict evolves.

NIESR economists said Rachel Reeves faces "tough choices" over the size of any energy support package for poorer households and what the report characterised as potentially "fanciful" demands for rapid increases to the defence budget, according to the City AM report.

For operators reliant on government contracts or public-sector demand, the signal is clear. Competing fiscal pressures from defence, energy support and debt servicing are likely to crowd out discretionary spending on business support programmes, infrastructure and growth-oriented policy. Capital budgets that were already under strain before the conflict face further compression.

What operators should be watching

Cost of debt

The trajectory of the base rate matters more than its current level. Under NIESR's central case, a single 25-basis-point hike is expected as early as July. Under the stress scenario, 150 basis points of tightening would represent a significant reversal. Businesses with floating-rate facilities or near-term maturities should be modelling both paths against cash flow.

Energy exposure

Brent crude at $140 per barrel is a stress test, not a forecast. But current prices are already elevated relative to pre-conflict levels, and the NIESR report notes that UK wholesale energy costs are particularly sensitive to global oil price movements. The think tank observed that current carbon tax systems do not address imported energy supplies and that energy storage is "the main lesson to be learned" for the UK from the war. Firms with unhedged energy exposure face margin risk that compounds quickly if the conflict escalates.

Fiscal policy signals

The erosion of the £23.6bn headroom changes the political calculus around taxation and spending. City AM's Shadow MPC members warned that a higher fiscal risk premium could become "embedded" in gilt yields, raising borrowing costs for the sovereign and, by extension, for corporates. Any autumn fiscal statement or emergency budget would be the next concrete signal of where the burden falls.

North Sea policy

NIESR's report suggested that lifting restrictions on new oil and gas exploration licences in the North Sea would not alleviate short-term economic pressures but could make the economy "better prepared" for future shocks, according to the think tank. Any policy shift in that direction would have implications for the energy supply chain and for firms operating in adjacent sectors.

Consumer demand

Inflation above four per cent, rising mortgage costs and the possibility of an energy support package that falls short of need all point to weaker household spending. Businesses exposed to discretionary consumer demand should be stress-testing revenue assumptions against a prolonged period of subdued real wage growth.

The NIESR report does not offer a single prediction. It offers a range of outcomes, from a narrow avoidance of recession to a material contraction in national income. The common thread across all scenarios is that the margin for error, for the Treasury, for the Bank of England, and for businesses, has become considerably thinner.