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1. A new ‘stagflationary’ shock
2. Economic & financial forecasts
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The UK economy, still bearing the marks of the 2022 energy crisis, is confronting a fresh external supply shock stemming from the war in the Middle East. The economic situation prior to this conflict was fragile: GDP growth was still very modest in the second half of 2025; the unemployment rate had risen; and a surge in inflation eroded the household purchasing power against a backdrop of subdued wage growth.
Rising gas and oil prices on global markets are expected to trigger an increase in consumer price inflation from March onwards, with more significant effects from the third quarter. We now anticipate inflation of close to 3.5% in the second half of the year, compared to forecasts below the 2% target three months ago. Higher inflation will weigh on real disposable income and household consumption. Investment prospects have also deteriorated. Business confidence will decline, hampered by uncertainty over the outlook for demand; production costs will rise and margins, already under pressure, will erode further. Against this backdrop, we believe the risk of a wage-price spiral is less likely to materialise than during previous shocks. We anticipate only one rate hike by the Bank of England (BoE) this year, in the second quarter, compared with the more than two hikes anticipated by the markets, and a resumption of monetary easing in the second quarter of 2027.
Contacts / Experts
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CitationThe war in the Gulf is casting a shadow over household consumption prospects, particularly for those on the lowest incomes, whose standard of living has deteriorated significantly in recent years. According to the Resolution Foundation, incomes for the poorest half of households (excluding pensioners) have remained virtually stable over the last twenty years (rising by just 0.5% per year compared with 4% in the decade prior to 2005). Energy and food account for the bulk of these households’ expenditure, and they have little savings to maintain their purchasing power. Despite the expansion of renewable energy in recent years, natural gas remains crucial for the UK. Around 85% of households use natural gas for heating, and it accounts for 30% of the energy used to generate electricity. The price of electricity continues to be largely determined by the price of natural gas due to the marginal pricing system (where the market price is determined by the cost of producing the last unit of electricity needed to meet demand at any given time).
