Press Story

Prolonged conflict in the Middle East could cost the Treasury up to £8 billion a year through higher debt interest payments and lost tax revenue

Think tank says inflation could peak as high as 5.8 per cent, and urges government to act to prevent Bank of England interest rate increases and hits to growth

IPPR recommends a temporary energy price cap at £2,000 to target the most severe scenarios and a 10p fuel duty cut, alongside lower speed limits to help reduce energy demand

A new report from the Institute for Public Policy Research (IPPR) recommends the government act urgently to mitigate the risk of Trump’s war in Iran from causing long-term damage to the UK economy and public finances.

The think tank warns a prolonged conflict in the Middle East could cost the Treasury up to £8 billion a year through higher debt servicing costs and lower tax revenues. Over a quarter of UK debt is index-linked, so every extra point of inflation feeds directly through to debt payments.

New modelling finds that, without intervention, CPI inflation could peak at 5.8 per cent in a prolonged ‘stalemate’ scenario – well above the Bank of England’s 2 per cent target – and real GDP growth could fall as low as 0.3 per cent.

However, IPPR finds that a targeted package of support could reduce inflation, protect growth, avoid the need for damaging interest rate rises, and ultimately save the government money if the shock continues. This would include:

Introducing a temporary energy price cap at £2,000 - designed to activate only in the most severe scenarios - to limit inflation while maintaining incentives to reduce consumption
Implementing a temporary 10p fuel duty cut to offset rising oil prices
Pairing support with measures to reduce energy demand, including lower speed limits
Funding support through targeted, progressive tax measures, including strengthened windfall taxes on energy profits

The package would cost up to £5 billion a year depending on the severity of the shock. At worst, the intervention is broadly fiscally neutral, with policy costs offset by lower borrowing costs and protected tax revenues.

However, if intervention succeeds in preventing permanent ‘scarring’ damage to the economy, or in averting sharper interest rate rises, the government could stand to save between £6-10 billion a year compared to doing nothing.

The authors say this package demonstrates lessons learned from Liz Truss’s response to the 2022 energy crisis, which cost £76bn.

William Ellis, senior economist at IPPR, said:

“The UK cannot afford to sit back and let another energy shock drive up inflation and damage the economy. The UK economy and public finances are expected to take a significant hit from the Iran conflict, regardless of whether the government intervenes.

“The Bank of England is not well suited to respond, given the lag that it takes for interest rates take to influence demand. However, as the Bank set out last week, it is still likely to increase interest rates to guard against second round effects and high inflation expectations – particularly if the conflict escalates.

“The government can act now where the Bank can’t, with a well-designed policy that acts to cap prices only in the most damaging scenarios. At worst, this would save about as much as it costs – but if permanent damage or sharp interest rate rises are avoided, this could end up saving money.”

Sam Alvis, associate director at IPPR, said:

“A well-designed intervention, that pairs capping prices with clear incentives to reduce energy demand, would not only protect living standards but prevent the need for damaging interest rate rises, and insure against the risk of more severe damage.

“This is cost-effective, and if permanent damage is avoided, this actually saves the government money. Keeping interest rates lower and investment higher prevents any damage to deploying and using clean energy, the long-term solution to crises like this.

“The lesson from Liz Truss is clear: it’s not intervention that spooks markets, it’s poor policy design and an ignorance of investors' concerns. With the right approach, the government can act decisively and responsibly at the same time.”

ENDS

Sam Alvis and William Ellis are available for interview

CONTACT

Liam Evans, head of news and media: 07419 365 334 l.evans@ippr.org

Rosie Okumbe, digital and media officer: 07825 185421 r.okumbe@ippr.org

David Wastell, director of news and communications: 07921 403651 d.wastell@ippr.org

NOTES TO EDITORS

Advance copies of the report are available under embargo on request
IPPR (the Institute for Public Policy Research) is the UK’s most influential think tank, with alumni in Downing Street, the cabinet and parliament. We are the practical ideas factory behind many of the current government’s flagship policies, including changes to fiscal rules, the creation of a National Wealth Fund, GB Energy, devolution, and reforms to the NHS. As an independent charity working towards a fairer, greener, and more prosperous society, we have spent almost 40 years creating tangible progressive change - turning bold ideas into common sense realities. www.ippr.org