UK growth risks stalling at 0.3% as Iran war closes Hormuz

UK growth could stall at 0.3% in 2027 as the Iran war closes the Strait of Hormuz, Treasury modelling warns, threatening the G7's fastest-growing economy.

"Fiscal credibility is the bedrock, not just of economic stability, but it's the bedrock of our national security as well. A country that can't pay its way, can't defend itself," John Healey, Chancellor of the Exchequer, said.

The worst-case scenario presented to Prime Minister Andy Burnham and Healey assumes the strait — which handles roughly 21% of global oil trade — remains effectively shut for five more months, with no permanent US-Iran peace deal until the new year. Under that modelling, UK growth would reach just 0.9% in 2026, below the Office for Budget Responsibility's 1.1% forecast, and 0.3% in 2027 versus the OBR's 1.6% projection. Inflation would peak at 4.3% in the first quarter of next year, up from 2.6% currently.

The projections land weeks before Healey's maiden Budget on 28 October, forcing the chancellor to weigh cost-of-living relief against fiscal discipline. The Iran war has already eroded the near-£24 billion fiscal buffer inherited from predecessor Rachel Reeves to roughly £10 billion, according to the Resolution Foundation, while Capital Economics estimates Burnham's policy pledges require £25 billion of tax rises to fund.

Official figures released Thursday showed the economy expanded 0.4% in the second quarter, in line with market expectations but below the 0.6% gain in the first three months of the year. The Office for National Statistics said growth had "remained relatively robust," with the UK ahead of other G7 countries for growth so far this year. The economy is now 1.2% larger than a year ago.

June's month-on-month growth of 0.3% was helped by the men's football World Cup and summer heatwaves, while May's reading was revised down from 0.1% to zero. Sectors including computer programming, advertising and pharmaceuticals lifted growth, offset by falls in power generation and sewerage.

"The economy has shown welcome resilience so far, but we are not out of the woods yet," said Fergus Jimenez-England, associate economist at the National Institute of Economic and Social Research. "Both inflation and unemployment are set to rise in the coming months while business sentiment remains fragile and could dampen further with ongoing energy price volatility."

The International Energy Agency warned oil stockpiles were "rapidly depleting" with the strait all but impassable. Higher energy prices are already feeding through to household bills, and annual increases in benefits tied to inflation will compound the pressure on public spending.

Budget arithmetic tightens

Healey must also find roughly £4.7 billion in the Budget for extra defence spending, about £1.2 billion per year. The prime minister has pledged to launch the largest council house-building programme in decades, overhaul social care and raise defence spending — commitments that Capital Economics says could require £25 billion of tax rises.

Suren Thiru, chief economist at the Institute of Chartered Accountants in England and Wales, said households and firms had "largely shrugged off the shockwaves from the Iran war," but much of the second-quarter growth was driven by "temporary factors." He expects a "more painful deceleration" in coming months, making the Budget "more challenging."

Shadow chancellor Sir Mel Stride said Labour had "mismanaged the economy with their tax and borrowing spree, leaving it weak and vulnerable to the effects of shocks like the Iran War." Liberal Democrat Treasury spokesperson Daisy Cooper called the figures "little to celebrate," urging Burnham to pursue a new trade deal with the EU including Single Market membership.

The last time UK growth fell below 0.5% was in 2023, when Vladimir Putin's invasion of Ukraine triggered an energy crisis that pushed inflation above 10%. The current trajectory — with oil near $90 and the strait closed — risks a similar shock, though the Treasury's worst-case scenario assumes the disruption ends by the new year.

This article is for informational purposes only and does not constitute investment advice.