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UK economy faces turbulence as Middle East conflict drives up energy and borrowing costs

Households and businesses brace for harder times as energy bills soar and borrowing tightens. Will the UK's emergency measures be enough to weather the storm?

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2 min read
The image shows a graph depicting the conflict mitigation funding in Sudan. The graph is...
The image shows a graph depicting the conflict mitigation funding in Sudan. The graph is accompanied by text that provides further details about the funding.

UK economy faces turbulence as Middle East conflict drives up energy and borrowing costs

The escalating conflict in the Middle East has deepened financial risks for the UK, according to warnings from the Bank of England. Rising energy costs, higher borrowing rates and stretched markets are putting pressure on households and businesses alike.

The crisis has already triggered sharp increases in mortgage rates, with average two-year fixed deals climbing by 0.8 percentage points in just one month. Analysts now predict that nearly half of UK mortgage holders could see repayments rise by late 2028.

The UK's exposure to the Iran conflict stems from its heavy reliance on imported energy and sensitivity to rising borrowing costs. In response, the government has rolled out sweeping interventions—extending the Energy Bills Support Scheme with £400 per household, enforcing Ofgem price caps, and imposing a 75% windfall tax on oil and gas profits. These measures mark a stark shift from past crises: the 1970s oil shocks saw limited subsidies and later deregulation under Thatcher, while the 2022 Ukraine-related energy squeeze relied on temporary £150 Council Tax rebates and a milder Energy Price Guarantee.

The Bank of England has flagged growing strains in the financial system. While UK banks remain resilient, the collapse of property lender Market Financial Solutions revealed vulnerabilities in riskier credit markets. Hedge funds' use of debt to bet on UK bonds also remains unusually high, adding to instability. Meanwhile, US tech firms—particularly those in AI—face overinflated valuations, further complicating global financial conditions. The conflict's economic fallout is expected to drag on growth, push up inflation, and tighten credit. Sovereign debt pressures have worsened worldwide, leaving governments with less room to manoeuvre if new shocks emerge. Private credit markets, already under stress, could see deeper cracks as borrowing costs climb and valuations stretch thin.

The UK's financial system is bracing for prolonged turbulence as the Iran conflict disrupts energy markets and borrowing costs. With mortgage rates rising and government debt constraints tightening, households and businesses face a tougher economic landscape.

The Bank of England's warnings underscore the need for vigilance, as stretched valuations and high-risk credit bets add to the uncertainty. How policymakers navigate these challenges will shape the country's financial stability in the years ahead.

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