UK inflation could rise to 3% by the end of the year, driven by escalating tensions in the Middle East, according to the Office for Budget Responsibility (OBR). The assessment, delivered to the Commons Treasury committee on Tuesday, marks a significant upward revision from previous forecasts and reflects the growing economic impact of the conflict between the US, Israel and Iran.
David Miles, a senior figure at the OBR, stated that the potential for a prolonged conflict is stoking inflationary pressures through increased energy prices. While the price of oil fell on Tuesday after peaking above $100 a barrel on Sunday, it remains substantially higher than before military action began against Iran just under two weeks ago, trading at $85 a barrel in the evening. Gas prices have also increased by more than 50%.
“If there is no change in the picture on prices from now on forward, we estimate something like a 1% higher level of consumer prices in the UK by the end of the year,” Miles told MPs. He cautioned that the situation is volatile, adding, “I’d have given you a different answer probably yesterday morning, and by the end of this week, it could look different again.”
The OBR’s warning comes as Chancellor Rachel Reeves acknowledged rising inflationary pressures stemming from the Middle East conflict. However, she defended the government’s decision not to scrap a planned 5p rise in fuel duty scheduled for September, citing recent volatility in oil prices. “So things are very volatile at the moment,” Reeves told the Commons. “Which is why… the most important thing we can do to address the cost of living challenges people face is to de-escalate the conflict in the Middle East.”
Fuel prices have already begun to climb, increasing by 3.5p to 135.67p per litre for petrol and 6.9p to 149.01p per litre for diesel – the fastest rate of increase since 2022. Reeves is scheduled to meet with petrol retailers this week to address concerns about price increases at the pump and has pledged to prevent “price gouging,” following reports of some garages charging nearly 180p per litre.
Headline inflation in the UK currently stands at 3%, a decrease from a peak of 3.8% last year. It had been anticipated to fall closer to the 2% target this year, aided by government measures to reduce energy bills. However, the potential for a drawn-out conflict in the Middle East threatens to reverse this trend. Inflation reached 11.1% in late 2022, the highest level in four decades, following Russia’s invasion of Ukraine and the subsequent energy crisis.
The prospect of higher inflation has led the City to reassess expectations for interest rate cuts. Analysts now believe the Bank of England is unlikely to lower borrowing costs at its next policy meeting, with some suggesting that rates may even need to rise, adding further strain on households.
Miles indicated that the government may face significant costs to shield British households from soaring energy prices, but highlighted the limited fiscal space available to Reeves. He drew a comparison to the energy price guarantee implemented by the previous government in response to the Ukraine war, which cost approximately £50 billion. Reeves currently has £23 billion of headroom against her borrowing rules. “So £50bn in a context when you’ve got, in a sense, £23bn or so, is one indication of how difficult it would be to have a support package on that scale,” Miles said. “But so far the price changes are nowhere near what they were back then.”
