Britain’s economy is set to stall for the remainder of the year, according to new forecasts from Morgan Stanley, which warned that the economic fallout from the Iran conflict could significantly weaken growth, increase unemployment and intensify pressure on the UK public finances.
The bank’s chief UK economist, Bruna Skarica, said the UK economy is expected to “flatline” after a relatively solid start to 2026, as households maintain elevated savings levels and real disposable income growth remains close to zero.
Morgan Stanley forecasts that higher energy costs linked to the Middle East conflict will push inflation higher, while unemployment is expected to rise from 4.9% to 5.5% as consumer spending weakens.
According to the bank, household spending is unlikely to increase meaningfully this year, suggesting living standards may remain under pressure for at least another 12 months.
The report also warned that the economic impact of the Iran war has effectively halved Chancellor Rachel Reeves’ fiscal headroom against borrowing targets, creating an estimated £11 billion deterioration in the UK’s public finances.
The warning comes amid rising political uncertainty surrounding Prime Minister Keir Starmer, with investors increasingly concerned that a potential Labour leadership contest could lead to higher public spending commitments and wider budget deficits.
UK government borrowing costs have risen sharply in recent sessions, with long-term gilt yields reaching their highest levels since the late 1990s as markets reassess fiscal risks.
Despite the gloomy outlook, Morgan Stanley believes the Bank of England is unlikely to raise interest rates further from the current 3.75% level this year and could instead cut rates to 3.5% during 2027, assuming energy prices begin to ease.
However, the bank cautioned that a renewed escalation in the Middle East conflict — particularly if oil prices were to surge towards USD150 per barrel — could trigger a deeper downturn and potentially push both the global and UK economies into recession.
