British households face a “pretty grim picture” for living standards as the war in the Middle East drags down growth and triggers a fresh cost of living crisis, the government’s independent forecaster has said.
In a report as John Healey announced his first budget, the Office for Budget Responsibility (OBR) issued a sharp downgrade for growth in ۲۰۲۷, household disposable incomes 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 ۲۰۲۷ and warned that inflation was poised to reach close to ۴% as Britain’s early resilience to the war fizzles out.
While growth this year was upgraded from ۱.۱% to ۱.۲% after an unexpectedly resilient performance fuelled by AI investment, the watchdog slashed its estimate for next year from ۱.۵% to ۱%.
Highlighting the damage from Donald Trump’s war in the Gulf, Healey said the exchequer was spending £۱۴bn 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 £۱۵bn 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 £۲۳.۶bn left by his predecessor, Rachel Reeves, in the spring.
As a consequence, the OBR said borrowing was poised to fall to about ۲% 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 ۳.۵% this year, significantly higher than the ۲% forecast in March.
The outlook for household disposable income in the UK was “a pretty grim picture”, David Miles of the OBR said.
“If you go back to just before Covid, and take that as your base, where we are right now – seven years later, is virtually no growth in per person real household disposable income,” he said. “That’s pretty unusual in the history of the UK.”
Healey made helping families with the cost of living a core focus of his first budget, including £۱۰۰ in blanket payments for ۲۰ million households at a cost to the exchequer of £۲.۶bn 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 ۲% above pre-pandemic levels by the start of the ۲۰۳۰s.
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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 G۷ in the first half of ۲۰۲۶. 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.
“There are real challenges ahead but Britain has beaten the forecasts this year, and with the action I am taking today I believe Britain can beat the forecasts again,” he said.
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 $۷۰ a barrel to more than $۱۱۵, while gas prices have almost tripled.
With a tentative pause in the fighting while Donald Trump prepares for crunch midterm elections, the OBR said the outlook for the economy, households and the UK public finances remained highly uncertain.
Suggesting there were “significantly better or worse outcomes of broadly equal probability”, it said that if energy prices were to rise to a higher and more sustained peak, government borrowing could be £۱۷bn above the central forecast next year. However, a lower energy price path could reduce borrowing by £۱۲bn.
