2026 GDP growth forecast is halved by war in the Middle East. Our economics partner Oxford Economics (OE) has reduced its UK growth forecast for 2026 to 0.4% from 0.9% because of the conflict. Higher oil and gas prices will significantly increase inflation; and the return of inflation means that interest rate cuts will stay on hold.
Worst-case trade war
US trade deals prove fragile. The US effective tariff rate rises to 33% in Q1 2026, far above the 13% level in the baseline. China is particularly hard hit, with an effective tariff rate of around 125%. Affected economies hit back with corresponding tariffs on US exports.
Tighter fiscal policy
Investor concerns over Japan's fiscal position spread to other economies, prompting governments to take action to tackle rising public debt levels. Initial hits to GDP growth are eventually unwound as interest rate cuts from the Federal Reserve and a partial unwind of fiscal measures support recovery beyond 2028.
AI boom
AI-driven investment surge lifts global growth. Booming US tech spending and stock markets, powered by rapid AI adoption and productivity gains, mirroring the upswing witnessed in the 1990s.
Tech downturn
AI boom turns to bust, with global growth slowing sharply under the weight of falls in stock prices and investment. US tech stocks fall by 25% in the first year of the scenario.
Key drivers of the short-term outlook
- The duration and severity of the US/Israel-Iran conflict is uncertain: OE’s baseline forecast assumes that oil and gas prices will remain elevated in Q2 before dropping back gradually.
- The impact of past rate hikes will continue to emerge: OE estimate that these borrowers face an increase in their mortgage rate of 250bps-300bps.
- Consumers likely to save less: Households have been very cautious in recent years, saving an unusually high share of their income and showing muted demand for credit.
- Real household incomes are expected to fall: While household income growth was already expected to be sluggish, the economic hit from the Iran conflict means that OE now predicts a fall of 0.8% in real incomes in 2026.
What to watch out for
- Conflict in the Middle East: The conflict’s duration and impact on oil and gas prices are uncertain, but cost hikes would negatively affect the UK due to its reliance on imported gas.
- Elevated fiscal risk. Market reaction to November’s Budget was positive, but fiscal consolidation via tax rises may not meet targets in an election year.
- Planning reforms. Government aims to boost growth via easier housebuilding, but past reforms suggest results will take time.
- Challenging political backdrop. Labour’s unpopular leadership and potential shift left could undermine market confidence.
- Immigration reforms. Tighter immigration rules may slow growth and create skills shortages.
Produced by the Foresight Factory for the IPA Commercial Group
