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Economic update: Unexpected resilience as conflict continues

Six months on from its beginning, the current Israel/US conflict with Iran continues to affect the UK economy. However, indicators suggest that the economy is coping better than forecasters expected.

GDP growth remains steady as productivity rises

In April, the International Monetary Fund (IMF) warned that the conflict with Iran was likely to hit the UK’s economy particularly hard, and forecast that the UK’s GDP would grow by only 0.8% in 2026. However, the latest GDP figures show that GDP grew by about 1.1% in April to June 2026, compared with the year before. Independent forecasters surveyed by HM Treasury think, on average, that the economy will grow at this rate in 2026 as a whole as well.

This continues the trend since around 2024 (shown in the chart on the left below), in which the economy appears to have returned to steady (if not spectacular) growth, following several years of stagnation after the covid-19 pandemic.

Source: ONS, GDP monthly estimate, UK: June 2026, 13 August 2026, and Productivity flash estimate and overview, UK: April to June 2026 and January to March 2026, 18 August 2026

As the chart on the right (above) shows, this increase has also coincided with an increase in productivity (the amount of economic output for each hour worked). Productivity is difficult to measure, particularly given the problems with measuring employment that the Office for National Statistics (ONS) has had in recent years. However, recent estimates based on administrative data (such as Pay As You Earn data) suggest that productivity has genuinely increased in recent years.

Analysis of this data by the Resolution Foundation (a think tank focusing on UK living standards) suggests that productivity growth is now higher than it was in the late 2010s, and that this really does reflect an improvement in the productivity of various sectors (rather than simply the loss of less productive jobs).

Business and consumer confidence in the economy appears to be increasing as well. There were improvements in August in all three of the measures tracked by the Library; for example, the GfK Consumer Confidence Index rose to its highest level in two years.

Inflation feels the effect of the Iran conflict

Consumer price inflation rose to 2.9% in July, largely as a result of the conflict in the Middle East filtering through to household energy prices (see the chart on the left, below). July was the first point at which the Ofgem price cap was affected by the increase in wholesale energy prices caused by the conflict, and this caused average gas prices to rise by about 15% compared with June.

The increase in the inflation rate was in line with the expectations of economists polled by Reuters, but it was still well above the Bank of England’s 2% target.

Source: ONS, Consumer price inflation, UK: July 2026, 19 August 2026; Bank of England database, series IUMB34, IUMB37 and IUMBV42, retrieved 25 August 2026

Mortgage borrowing costs do not make up part of the CPI measure of inflation, but these have also been affected by the conflict. As the chart on the right (above) shows, the rates available on fixed-rate deals sharply increased in March 2026 and have only decreased slowly since then.

Government borrowing (and costs) increase

The government borrowed slightly more than expected in July, with public sector net borrowing at £1.8 billion. Net borrowing is normally relatively low in July, because a large amount of self-assessed tax revenue is collected in that month. The Office for Budget Responsibility had forecast a small surplus of £0.5 billion in July; actual borrowing was therefore £2.3 billion above forecast.

However, these amounts are relatively small compared to total borrowing (and in any case these figures are subject to revision in later releases). As the chart on the left below shows, total borrowing so far in 2026/27 remains broadly in line with the OBR’s forecast, and slightly lower than last year. These forecasts will be updated at the next Budget, which the Chancellor has said will take place on 28 October.

Note: “PSNB ex” = public sector net borrowing, excluding banks in the public sector.

Source: ONS, Public sector finances, UK: July 2026, 21 August 2026; Debt Management Office, Historical Average Daily Conventional Gilt Yields, retrieved 25 August 2026

The costs of this borrowing have also been increasing in recent months. As the chart on the right (above) shows, bond yields (which indicate the rate at which the government can borrow) rose in the spring of 2026. According to the Bank of England’s Monetary Policy Report in July 2026, 5-year and 10-year bond yields are now “at around their highest level since 2008”.

Labour market weaknesses continue

There has been ongoing weakness in the UK labour market in recent months, and the latest data gives no reason to think this will change in the near future. The numbers of payrolled employees and vacancies have both continued to fall, while average pay (excluding bonuses) increased by less than 1% above inflation over the last year.

Employment continues to be a particular problem for the services sector. Respondents to S&P Global’s Purchasing Managers’ Index survey (PDF) indicate that jobs have been lost in services in each of the last 23 months, the longest continuous stretch since the survey began in 1996.