Britain’s economy has taken a multibillion-pound hit as the war in the Middle East drags down growth and triggers a fresh cost of living crisis, according to the government’s independent forecaster. In a report as John Healey announced his first budget, the Office for Budget Responsibility (OBR) issued a sharp downgrade for growth, living standards and the public finances despite the measures taken by the chancellor. Although Healey sought to cushion the blow through “breathing space” policies to help households and businesses with soaring energy costs, the watchdog slashed its growth forecasts for 2027 and warned that inflation was poised to reach close to 4% as Britain’s early resilience to the war fizzles out.
While growth this year was upgraded from 1.1% to 1.2% after an unexpectedly resilient performance fuelled by AI investment, the watchdog slashed its estimate for next year from 1.6% to 1%. Highlighting the damage from Donald Trump’s war in the Gulf, Healey said the exchequer was spending £14bn more on debt interest as the financial market fallout from the conflict pushes up borrowing costs for governments worldwide. Against a highly uncertain global backdrop, the chancellor said he would allow a hit to his buffer against the government’s fiscal rules – while also announcing a temporary rise in tax on banks to fund his package of energy support.
He left £15bn of headroom against the main fiscal rule, which requires day-to-day spending to be matched by tax receipts in three years’ time – down from £23.6bn left by his predecessor, Rachel Reeves, in the spring. As a consequence, the OBR said borrowing was poised to fall to about 2% of GDP in the medium term but at a slower near-term pace than previous plans. As the energy price shock rippling out from the Middle East hits households and businesses, the OBR said consumers would face inflation of 3.5% this year, significantly higher than the 2% forecast in March.
Healey made helping families with the cost of living a core focus of his first budget, including £100 in blanket payments for 20 million households at a cost to the exchequer of £2.6bn and a plan to abolish standing charges on gas bills. Despite the measures, the OBR warned that households would come under sustained pressure, with per-person disposable incomes taking account of inflation expected to fall in the short-term before rising modestly before the end of the current parliament. Setting the stage for a tough election run-up for Labour, the watchdog said income levels would only be about 2% above pre-pandemic levels by the start of the 2030s.
Britain’s economy had shown more resilience than had been expected at the start of the Iran war, after recording the strongest rate of growth in the G7 in the first half of 2026. Official figures suggested a strong expansion in AI-related business activity as one factor behind the surprise rise. Healey sought to use his budget to harness the power of the technology to boost growth in future while also safeguarding the country against the risk of cyber-attacks amid the accelerating global AI race.
Although saying he would never be complacent, Healey said there were “signs of resilience” in the economy as he highlighted that the Bank of England and the International Monetary Fund had issued growth upgrades for the UK within recent months. However, the economy is coming under mounting pressure from the energy price shock triggered by the war. Since the start of the US-Israeli led invasion of Iran at the end of February, which has throttled energy flows in the region, oil prices have risen from about $70 a barrel to more than $115, while gas prices have almost tripled.
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