UK Public Finances Face Pressure from Iran War, Experts Warn

City economists are warning that UK government borrowing is set to be driven higher by the Iran war, following a small drop in the annual deficit in the last financial year.

Lindsay James, investment strategist at Quilter, stated: “The conflict in the Middle East has shown the UK economy remains very exposed to geopolitical shocks. However, there are some encouraging signs that rigid fiscal rules have been having the desired effect thus far, as today’s public sector finance data shows borrowing was £12.6 billion in March. This is £1.4 billion less than the same month last year, and the lowest March reading since 2022.

“Borrowing had been expected to be lower this year as the government had front loaded a lot of its spending plans into its early years, but things could get more difficult from here on out. With inflation on the rise, debt interest climbing again and gilt yields also becoming elevated once more, the fiscal headroom Chancellor Rachel Reeves had established could very quickly run out once again. As such, tax is likely to feature prominently as the lever to pull to help keep the public finances on steady ground, and we have already seen the burden this places on growth.”

Ruth Gregory, deputy chief UK economist at Capital Economics, warns that borrowing will probably rise in the current financial year (April to next March).

“March’s figures showed an unexpected undershoot of the OBR’s forecast for public borrowing in 2025/26. But we do not expect this improvement to last long. We think the energy price shock will mean that borrowing overshoots the OBR’s forecast by a huge £29bn for the 2026/27 fiscal year and by about £13bn in subsequent years.”

Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK, predicts that March could be the last month of good news on borrowing for a while:

“The good news for the Chancellor is that full year borrowing for 2025/26 came in at £132.bn, down from £151.9bn in the previous financial year, and in line with the latest OBR forecast. The bad news is that the war in Iran means the situation will deteriorate sharply over the rest of this year. That will limit her ability to offer households and businesses a significant bailout if energy prices move higher.

“Looking ahead, March will probably be the last month of good news on borrowing. Gilt yields are down from their 5% peak in March, but are still significantly higher than before the war. Borrowing costs will rise quickly from here though, as higher interest payments on index-linked gilts weaken the near-term fiscal position. At the same time, the economy will almost certainly slow, which could send the unemployment rate trending back up. That would lower income tax receipts and raise welfare spending.”

Sheena McGuinness, co-head of energy and natural resources at RSM UK, says the drop in UK fuel duty revenues last month is part of the longer-term shift to electric vehicles, adding:

“With the ongoing conflict in Iran causing concerns over fuel shortages and spiking prices, the downtick may also be driven by consumers beginning to limit their vehicle usage to necessary journeys.”

The UK’s revenue from fuel duty fell to £1.8bn in March, the lowest for any month since July 2023, Reuters has spotted.

While representing only a fraction of government revenue, the drop in fuel duty in response to higher prices for petrol and diesel could be an early warning sign of how the war might weaken activity across the economy and hit overall tax revenues.

Gas prices have risen this morning too.

The month-ahead UK wholesale gas contract is up 4.8% at 113.7p per therm, its highest in over a week.

Before the Iran war began at the end of February, UK gas was trading below 80p a therm, but rose as high as 180p/therm in March.

European gas prices are up 4.3% too, to €45.4 per megawatt hour.

Looking ahead, analysts at Unicredit fear that European gas prices will face upside pressure in the coming months.

Europe needs to import around 54bcm to replenish its gas stocks before the 2026-27 winter heating season begins. While this had previously looked feasible in light of an estimated 45bcm in new LNG [liquefied natural gas] capacity that was expected to come online in 2026, this supply-growth forecast is being continually revised downward.

Not only is Qatar’s planned expansion unlikely to materialise in 2026, the blockade of the Strait of Hormuz also removes around 8bcm monthly from global supply and approximately 17% of Qatar’s capacity will reportedly be offline for several years due to war damage.

The oil price is rising above $100 a barrel this morning, as supplies through the strait of Hormuz remain badly disrupted by the Iran war.

Yesterday, Iranian forces have seized two ships in the crucial waterway as the US and Iran both doubled down on imposing separate blockades of the shipping waterway.

Mohammad Bagher Ghalibaf, the speaker of the Iranian parliament and lead negotiator, said late on Wednesday that reopening the strait of Hormuz would be “impossible” while the US and Israel committed “flagrant” breaches of the ceasefire, including the US naval blockade, “the hostage-taking of the world’s economy” and “Zionist warmongering”.

The deadlock has raised doubts about whether stalled peace negotiations will resume.

Brent crude is up almost 1% this morning at $102.80 a barrel.

The FTSE 100 index of blue-chip shares has dropped by 54 points, or 0.5%, in early trading, to 10,422 points.

Sainsbury’s (-5%) are among the top fallers after their warning about the impact of the Iran war.

The FTSE 250 index of medium-sized companies is down 0.75%. WH Smith (-11%) is leading the sell-off here, after it cut its profit forecast this morning.

The best way to look at government national debt is to compare it to the size of the economy – and here the picture is encouraging.

The £132bn which the UK borrowed in the financial year ending in March works out at 4.3% of gross domestic product (GDP).

That’s 0.9 percentage points less than in the year to March 2025 and is a six year low – the lowest since the year to March 2020 just before the Covid pandemic drove up borrowing.

However, economists are warning that the Iran war will drive UK borrowing higher, and slow growth, meaning that debt/GDP ratio may rise in the current financial year.

More UK companies are warning this morning that the Iran war will hurt their businesses.

Supermarket chain J Sainsbury told the City that it is ‘very unclear’ what the impact will be, saying: “The conflict in the Middle East will impact both our customers and our business. The duration and extent of these impacts is very uncertain and this is reflected in our profit guidance, where we currently expect to deliver Total underlying operating profit of between £975 million and £1,075 million. We continue to expect to deliver Retail free cash flow of more than £500 million.”

Estate agent Foxtons also reported a negative impact, with CEO Guy Gittins explaining: “The Sales market remains subdued and has been further affected by recent events in the Middle East, which have tempered buyer sentiment and impacted mortgage rates and availability. As ever, Foxtons is focused on what we can control by managing costs, increasing efficiencies and repositioning our Sales business to mitigate the impact of the market.”

And WH Smith, which operates at transport hubs, has lowered its profit forecast and said it was “taking a more cautious outlook” due to the impact of the conflict on passenger numbers and consumer morale.

It says: “In light of the uncertainty arising from the conflict in the Middle East, the Group is taking a more cautious outlook reflecting the impact on passenger numbers and weaker consumer confidence. At this stage, the Group expects to deliver FY26 Headline Group profit before tax and non-underlying items of £90m - £105m.”