RISKS TO THE OUTLOOK
Will domestic politics and Iran conflict derail the outlook?
Our base case for the UK economy has worsened considerably since our outlook at the start of the year. But the risks have arguably got even worse.
Will the Iran crisis continue to feed inflation?
The biggest risk to the outlook comes from the Iran crisis. The rise in oil and gas prices has already pushed up inflation, borrowing costs and uncertainty, which will all drag on growth this year.
However, the oil market is in a race against time (see Global context section) to resume supply through the Strait of Hormuz before stocks start to run dry. The big risk is that the new deal agreed between the US and Iran proves to be unsustainable and the Strait of Hormuz remains closed.
In this scenario, oil prices would soar well past the peaks registered in 2022 and stay high into 2027, resulting in another surge in inflation. What’s more, if energy prices remain elevated for a prolonged period, then second-round effects will become unavoidable as firms are forced to pass on costs. In turn, the MPC would then be forced to raise interest rates to dampen the inflation pressure, raising the cost of borrowing and further dragging on demand.
The combination of soaring inflation and rising unemployment would result in real household disposable incomes falling. At the same time, rising interest rates could prompt households to pare back spending. It would also depress investment spending by firms and lead to another jump in the unemployment rate.
On top of that, uncertainty will remain elevated, prompting households and firms to delay spending and investment.
Putting that all together, if the proposed US-Iran deal proves unsustainable and the Strait does not reopen then inflation could peak above 6% and a recession would be likely given the weaker demand backdrop compared to 2022.
How will Sir Keir Starmer’s resignation impact the economic outlook?
As if that wasn’t enough, the recent rise in uncertainty and borrowing costs has also been driven by the speculation around Sir Keir Starmer being replaced as Prime Minister. With a change in leadership now confirmed uncertainty is set to continue and potentially gather pace.
One risk here is that a messy, prolonged leadership contest opens a Pandora's box of tax speculation, damaging business and consumer confidence still further and dampening growth. Andy Burnham has announced his candidacy to succeed Starmer, and is the firm favourite, though the contest is not yet settled. Until we know what a Burnham government would actually look like, speculation will continue to feed uncertainty.
What’s more, Starmer being replaced by a more spendthrift leader, such as Andy Burnham, who would likely loosen the fiscal purse strings has already helped to push medium-term borrowing costs to the highest level since 2008. Were those plans to become apparent then the bond market would likely push yields higher, putting more pressure on the public finances and raising financing costs for firms even more.
If these risks materialise then we would not be surprised if the economy dips into a short recession later this year as a weak labour market, elevated inflation and persistently elevated uncertainty combine to drag down growth.
