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The UK faces the biggest hit to growth from the Middle East war of all G20 economies, the OECD has warned, underlining how exposed the country is to the global energy shock.
The Paris-based organisation downgraded its 2026 growth forecast to 0.7 per cent, from a previous prediction of 1.2 per cent, the steepest cut in the OECD’s interim economic outlook released on Thursday.
Inflation would accelerate to 4 per cent this year because of higher energy prices, the OECD said, the second-highest rate in the G7, and up from 3.4 per cent last year.
In a sign of the dilemma facing the Bank of England from the combination of weaker growth and higher inflation, the OECD said the central bank would hold back from raising interest rates this year.
The stark prediction of accelerating price rises and deteriorating growth underscores the UK’s exposure to the Middle East crisis through its reliance on oil and gas imports.
Sir Keir Starmer put the cost of living at the centre of his government’s political agenda at the start of the year, but the prime minister’s hopes of future interest rate cuts and easing price growth have been quashed by the recent surge in energy prices.
While financial markets are pricing in at least two quarter-point BoE interest rate increases this year, the OECD said it expected the central bank to keep its key rate at 3.75 per cent before lowering it by a quarter point in early 2027 as inflation moderates.
Consumer price inflation will fall to 2.6 per cent in the UK next year, still above the BoE’s target of 2 per cent, the OECD forecast.
The OECD’s UK growth forecast of 0.7 per cent is well below the 1.1 per cent forecast by the Office for Budget Responsibility earlier this month. Growth will pick up to 1.3 per cent next year, the OECD predicts, also shy of the OBR’s 1.6 per cent forecast, which was prepared before the attacks on Iran by the US and Israel.
“Central banks need to remain vigilant and ensure that inflation expectations stay well anchored,” the OECD said in its outlook, which was published on Thursday. “Monetary policy adjustments may be needed if price pressures broaden or if growth prospects weaken substantially.”
The crisis has sparked calls for interventions by the Treasury to alleviate pressure on household finances from rising energy costs, but the OECD warned that this would add to the “budgetary challenges” that most governments face. Pledges to spend more on defence will also add to those pressures.
Any measures to cushion the impact of higher energy prices should be “well-targeted on households most in need and viable firms”, the OECD said, while preserving incentives to lower energy use and containing “clear expiry mechanisms”.
Rachel Reeves, UK chancellor, insisted this week that the government would “learn the mistakes of the past” and not bail out wealthier households facing higher energy costs this winter.
Any help to households with their energy bills would be targeted, unlike the universal support instigated by former Conservative premier Liz Truss several months after Russia’s full-scale invasion of Ukraine in 2022, she said.
Responding to the OECD report, Reeves said: “The war in the Middle East is not one that we started, nor is it a war that we have joined. But it is a war that will have an impact on our country.
“In an uncertain world we have the right economic plan. The decisions we have taken have put us in a better position to protect the country’s finances and family finances from global instability.”