What we now know about the UK economy in four charts

Image source, Getty Images

ByMichael Race

Business reporter

The UK may have no involvement in the US-Iran war, but the country is feeling the full force of the conflict on its economy.

Soaring energy prices are set to dent growth in the short term, push up inflation and leave living standards in a "grim" place, according to the latest official forecast from the Office for Budget Responsibility (OBR).

Interest rates are also predicted to rise, making borrowing more expensive, along with government debt repayments.

Chancellor John Healey warned the nation faces "real challenges ahead" as he announced policies that he said would offer "breathing space" for households in the coming months.

"What we face today are global economic storms," he said. "We can't wish them away. We must choose the course we steer through them."

In its first assessment of the UK economy since the Middle East conflict started, the OBR said rising energy prices were the biggest risk to the economy in the near future.

Despite raising its growth forecast for this year, it sharply cut its prediction for next year from 1.6% to 1%.

Growth is then set to rebound in the following years.

When an economy grows, businesses tend to invest more, create more jobs and give pay rises to workers, which leaves people feeling better off on average, though it can take time and not everyone necessarily benefits.

Companies making higher profits also pay more in tax, which can enable the government to spend more on public services. When there is slow economic growth, or the economy shrinks, the opposite can occur.

Inflation can weigh on growth and the OBR has forecast that prices are set to rise at a faster pace as higher energy bills filter through supply chains and to consumers, especially in 2027.

High global oil prices have already hit drivers at the pumps, with petrol priced at almost £1.73 per litre on average, while diesel is near £1.99.

Elevated oil prices over time can lead to prices edging upwards across a host of goods, such as food, as companies pass on the higher expenses they face to consumers.

Goods are typically transported to destinations by lorries and vans, so high fuel prices can have far-reaching consequences.

The OBR now thinks inflation will stay higher for longer than previously forecast, peaking at 3.8% in 2027.

Despite the cost-of-living support announced by the government, economists at Pantheon Macroeconomics said the measures were "small beer given the surge in inflation we expect over the winter".

High inflation paints a bleak picture when it comes to living standards and the OBR has forecast a dip in the growth in living standards next year as energy bills hit the spending power of households.

Those on lower incomes are set to be hit harder, however, because energy costs eat up a bigger share of their monthly budget and disposable income.

Real household disposable income, a measure of living standards, is forecast to grow from 2027, but not by as much as previously thought.

"It's a pretty grim picture," according to the OBR's David Miles, who says there has been "virtually no growth" for individuals since before the Covid pandemic.

"It's been a dismal period in British economic history."

Inflation is expected to average 3.4% next year, before falling to the Bank of England's 2% target towards the end of the decade.

The Bank is widely expected to raise interest rates next week due to higher inflation in recent months. Rates are currently at 3.75%, but the OBR now forecasts they could rise to as high as 4.5% in the coming years.

It had previously forecast two interest rate cuts this year.

Higher rates makes borrowing money more expensive but can boost returns on savings.

Inflation also raises the cost of borrowing for the government, with spending on debt interest set to rise.

Such repayments are also predicted to increase the overall amount the government borrows, which is set to increase every year by more than had been previously forecast by the OBR.

Higher spending on welfare and pensions due to inflation is also expected to increase borrowing, though it is forecast to fall as a share of the economy over the next five years.

However, forecasts are only a best guess at what might happen in the future. Given the way the conflict in the Middle East has upended previous predictions, the future of the war could alter inflation expectations.

US President Donald Trump has suggested the war will end after the mid-term elections next month.

The OBR admitted there remained "significant uncertainty" around its predictions due to the changing situation in the Middle East.

Charts by Tommy Lumby and Rob England