OBR raises alarm about rising prices amid ongoing conflict in Iran

OBR Revises Inflation Outlook Amid Middle East Conflict

The Office for Budget Responsibility (OBR) has had to abandon its earlier forecasts of declining inflation, citing the ongoing conflict involving Iran as a source of exclusively negative repercussions.

Professor David Miles, a member of the OBR’s Budget Responsibility Committee, informed Parliament that the recent spike in oil and gas prices could push inflation about 1% higher than previously anticipated by the end of the year.

Addressing the Treasury select committee, Professor Miles explained, “If current price trends persist, we estimate that consumer prices in the UK could be roughly 1% higher by year’s end.”

He added, “This would mean inflation finishing the year closer to 3%, rather than the 2% target previously expected.”

Earlier OBR projections had anticipated the consumer prices index (CPI) would drop from 3% to the Bank of England’s 2% target by the end of the year. However, Professor Miles noted that a significant rise in oil prices has forced a reassessment.

This situation could result in interest rates remaining elevated for a longer period, with financial markets already reducing expectations for rate cuts and even considering the possibility of further increases.

While Professor Miles clarified that the inflationary impact would not match the surge seen after Russia’s 2022 invasion of Ukraine, he emphasized that the increase would still be “noticeable and entirely unwelcome.”

He stated, “As major importers of oil and gas, the UK faces only adverse effects from these higher prices.”

Potential for Even Higher Inflation

Professor Miles’s remarks coincided with warnings from Morgan Stanley, which suggested that UK inflation could exceed 5% if the Middle East conflict continues to drive up global energy prices. The bank cautioned that if Iran keeps the Strait of Hormuz closed for a month or more, global energy supplies could be severely restricted, significantly impacting the UK economy.

If inflation returns to 5%, it would mark the highest level since September 2023, when the UK was grappling with soaring energy costs following Russia’s invasion of Ukraine.

In addition to rising fuel prices, households are also preparing for increased energy bills.

Bruna Skarica, Morgan Stanley’s chief UK economist, predicted that household energy bills could climb by approximately 20% when the price cap is adjusted in July.

Impact on Households and the Economy

This adjustment would raise the average annual energy bill from £1,641 under April’s cap to around £1,970.

Skarica warned that further increases could occur in October as European countries replenish gas reserves over the summer, keeping prices elevated.

The prospect of higher inflation has already unsettled financial markets, with traders now expecting the Bank of England to maintain higher interest rates for an extended period.

The Bank’s Monetary Policy Committee, led by Governor Andrew Bailey, had been anticipated to lower rates from 3.75% to 3.5% soon, with another reduction possible later in the year. However, the risk of another energy price shock is likely to keep borrowing costs unchanged, and many analysts now doubt there will be any rate cuts this year.

The full economic impact will depend on how long energy supply disruptions persist, which would keep oil and gas prices high. Skarica noted, “If these conditions last, economic activity could stall from the second half of 2026.”

Government Response and Fiscal Challenges

The government has pledged to try to contain living costs, but any significant intervention to shield households from energy market volatility would be costly.

According to Skarica, offsetting the impact of higher energy bills for households could require around £6 billion.

She also pointed out that increased tax revenues from energy companies are already being offset by higher government borrowing costs, which have surged since the onset of the conflict.

Sanjay Raja of Deutsche Bank estimated that postponing the planned fuel duty increase from September to the end of the next financial year would cost about £700 million.

Alternatively, a six-month reduction in VAT on energy bills would result in a £1.4 billion loss for the Treasury, he said.

Reintroducing a scheme similar to 2022’s, which provided £300 to low-income households to help with living costs, would cost £2.4 billion.