UK Inflation Forecasts Disrupted by Sudden Spike in Global Energy Costs

Wholesale Gas Prices: A Rapid Escalation

UK wholesale gas prices have reached their highest levels in three years, according to data from Cornwall Insight. Prices have nearly doubled since the conflict began, surpassing the initial price shocks from the 2022 Ukraine war, though they remain below the peak levels of that period. The spike follows attacks by the United States and Israel on Iran, which have heightened concerns about disruptions to oil and liquefied natural gas (LNG) supplies through the Strait of Hormuz.

Gas prices are central to the UK’s energy landscape, influencing electricity costs, industrial production, and indirectly affecting food and other goods. The recent price increase has already triggered immediate effects, with petrol and diesel prices rising. The average cost of petrol has increased by nearly 2.5p per litre, and diesel by over 3p since the weekend. If oil prices exceed $81 per barrel, petrol prices could approach 136p per litre, with diesel prices rising even faster.

Household Energy Costs: A Growing Burden

The surge in gas prices has immediate implications for UK households, many of which are still recovering from the previous energy price shock. Ofgem, the energy regulator, had announced a 7% reduction in the price cap for April, bringing typical annual dual-fuel bills to £1,641. However, analysts now warn that this reduction may be temporary. Cornwall Insight has revised its forecast for the July to September price cap, predicting it could rise to £1,801—a £160 increase from the April cap. The Resolution Foundation has warned that sustained energy price shocks could add over £500 to the average household energy bill in the summer, with inflation rising by approximately a percentage point.

The impact is most severe for lower-income households, which spend more than twice as much of their budgets on energy compared to higher-income families. The National Institute of Economic and Social Research (NIESR) has modeled the effects of a prolonged conflict, predicting that a year of high energy prices could push inflation up by 0.7 percentage points and reduce GDP growth by 0.2% in 2026. If the conflict extends into 2027, the impact could worsen, with GDP falling by 0.3% relative to the baseline.

The OBR’s Forecast: A Flawed Basis

The Office for Budget Responsibility’s (OBR) spring forecast, which projected inflation falling to 2% for an extended period, was based on assumptions of stable energy prices. However, the rapid rise in gas prices has invalidated these assumptions. The OBR’s critical data point—gas price expectations—was outlined on page 109 of the spring forecast, where it assumed prices would remain stable. This has proven incorrect, with wholesale prices surging far beyond initial projections.

Chancellor Rachel Reeves’ economic strategy, which relied on these outdated assumptions, now faces scrutiny. David Miles of the Office for Budget Responsibility acknowledged that previous inflation projections have become “more uncertain” due to the energy price shock. He noted that the current situation is “particularly uncertain,” with gas and oil prices rising sharply in recent days. The OBR’s central expectation had been that inflation would fall toward the Bank of England’s 2% target by the end of 2026, but this outlook is now in jeopardy.

Economic Implications: Interest Rates and Growth

The energy price shock has also raised concerns about interest rates. The Bank of England’s base rate, which has remained at 3.75% since late 2025, is now under pressure to increase. The National Institute of Economic and Social Research (NIESR) has warned that a prolonged conflict could push interest rates above 4% by the end of 2026. This would have significant implications for mortgage holders, as fixed-rate deals are largely influenced by money market swap rates, which have already reached 30-day highs.

Analysts warn that financial instability could lead to a rapid shift in interest rate expectations. The NIESR modeled the impact of oil and gas prices increasing by 30% and 50% respectively over one year, predicting that this would stoke inflation in 2026 and into 2027 and push the base rate to 4.5%. If the conflict persists, the Bank of England may be forced to raise rates to combat inflation, potentially slowing economic growth.

Outlook: Uncertainty and Adaptation

While the immediate economic consequences of the Iran war are clear, the long-term impact remains uncertain. The OBR has acknowledged that its forecasts are now “more uncertain,” and the government has described the situation as “early days.” Chief Secretary to the Treasury James Murray emphasized that the conflict is still in its early stages, and the government is closely monitoring developments. However, the potential for prolonged disruption to Gulf oil and gas supplies remains a critical risk.

For households, the challenge is to navigate rising energy bills and the potential for higher inflation. For businesses, the cost of energy is a key factor in production and pricing, with industries reliant on gas for manufacturing and power generation facing significant pressure. The UK’s energy security, a key focus of recent government policy, now faces renewed scrutiny as the conflict threatens to disrupt global supply chains.