UK inflation could end the year higher than previously expected at 3% because of the US-Israel war in Iran, the government’s economics watchdog has said.
David Miles, a senior figure at the Office for Budget Responsibility (OBR), said inflation could end the year a percentage point higher than expected before the war, because of the energy price shock triggered by the crisis in the Middle East.
The oil price fell on Tuesday after rising above $100 (£75) a barrel on Sunday, but it is still significantly higher than before the US and Israel began bombing Iran just under a fortnight ago. A barrel of Brent crude was trading at $85 on Tuesday evening.
Miles told the Commons Treasury committee that if current energy prices were sustained, the UK would face a “material, significant” increase in inflation, delivering a noticeable and unwelcome increase in living costs for British households.
The oil price was nearly a fifth higher than before the military action began on Tuesday, and gas prices are up by more than 50%.
“If there is no change in the picture on the prices from now on forward, we estimate something like 1% higher consumer prices by the end of the year,” Miles said.
“That’s [the] orders of magnitude as of right now. I’d have given you a different answer probably yesterday morning, and by the end of this week, it could look different again. It’s not clear which way we go from here.”
His comments come after Rachel Reeves told Britain to prepare for rising inflationary pressures as the fallout from the war in the Middle East begins to feed through to domestic energy prices.
The chancellor continued to rebuff calls from opposition MPs to ditch a planned 5p rise in fuel duty in September as result of the Iran conflict.
“Of course we keep these things under review, but if you look at petrol prices, at oil prices today, they’re 24% lower than they were yesterday,” she told the Commons.
“So things are very volatile at the moment. Which is why, as I said yesterday, the most important thing we can do to address the cost of living challenges people face is to de-escalate the conflict in the Middle East.”
Fuel prices have risen at their fastest rate since 2022, increasing by 3.5p to 135.67p for a litre of petrol, while diesel has risen by 6.9p to 149.01p.
Reeves, who is meeting petrol retailers this week to raise concerns about prices at the pumps, said the government would not tolerate “price gouging” after some garages charged almost 180pa litre.
The chancellor has made the cost of living a top priority for Labour this year, including measures to cut energy bills. Economists, however, say the likelihood of a drawn-out US-Israeli war with Iran could drive up energy prices and stoke inflationary pressures in Britain and around the world.
Headline inflation in the UK is running at 3%, down from a peak of 3.8% last year, and had been expected to drop close to 2% this year with the help of the chancellor’s energy measures. Inflation reached 11.1% in late 2022, the highest level in four decades, after the energy crisis triggered by Russia’s invasion of Ukraine.
The prospect of higher UK inflation means the City is no longer expecting the Bank of England to cut interest rates at its policy meeting next week. Some analysts have said borrowing costs may need to rise, adding to pressure on households and dashing Labour hopes for a reprieve from Threadneedle Street.
Miles signalled that the government could face substantial costs to insulate British households from soaring energy prices, and said the chancellor had limited room within her self-imposed fiscal rules to take action.
He drew a comparison between the headroom of £23bn that Reeves has against her borrowing rules and a cost of about £50bn for the energy price guarantee used by the previous government to protect households from soaring gas and electricity prices after the Kremlin’s invasion of Ukraine.
He said recent oil and gas price increases had been substantially lower than four years ago, but the outlook remained highly uncertain.
“So £50bn in a context when you’ve got, in a sense, £23bn or so, is one indication of how difficult it would be to have a support package on that scale. But so far the price changes are nowhere near what they were back then,” he said.
