Starmer’s economic comeback

Iran shock puts Starmer’s economic comeback on ice

The U.K.’s politicians are only beginning to grapple with the long-term effects of conflict in the Middle East — and have little room for maneuver.

By Esther Webber

Keir Starmer’s keeping Britain out of the war in Iran — but he can’t duck the conflict’s grave economic consequences.

In a sign of growing fears about the impact of the war on Britain, the prime minister chaired a rare meeting of the government’s emergency COBRA committee Monday night, joined by senior ministers and Governor of the Bank of England Andrew Bailey.

Starmer’s top finance minister, Rachel Reeves, will update the House of Commons on the economic picture Tuesday, as an already-unpopular administration worries that chaos in the Middle East is shredding plans to lower the cost of living and get the British economy growing.

For Starmer’s government — headed for potentially brutal local elections in May — the crisis in the Gulf risks a nightmare combination of a rise in energy prices, interest rates, inflation and the cost of government borrowing that threatens to undermine everything he’s done since winning office.

Economists are now warning that even if Donald Trump’s promise of a “complete and total resolution of hostilities” with Iran were to bear fruit, the effects on the British economy could still last for months.

Already there are signs of a split within Starmer’s party over how to respond. Labour MPs want the government to think seriously about action to protect households — but Starmer and Reeves have long talked up the need for fiscal responsibility, and economists are warning that there’s little room for maneuver.

Jim O’Neill, a former Treasury minister who served as an adviser to Reeves, told POLITICO the government should “not get sucked into reacting to every external shock” and “concentrate on boosting our underlying growth trend.”

Why the UK is so hard hit

Just before the outbreak of war, there was reason for Starmer and Reeves to feel quietly optimistic about the long-stagnant British economy. The Bank of England had expected inflation to fall back sustainably toward its two percent target for the first time in five years, giving the central bank the space to carry on cutting interest rates. 

With the Iran war in full flow, it was forced to rewrite those forecasts at the Monetary Policy Committee’s meeting last week — and now sees inflation at around 3.5 percent by the summer.

The U.K. is a big net importer of energy and also needs constant imports of foreign capital to fund its budget and current account deficits. That’s made it one of first targets in the financial markets’ crosshairs. The government’s cost of borrowing has risen by more than half a percentage point over the last month.

That threatens both the real economy and Reeves’ painstakingly-negotiated budget arithmetic. Higher inflation means higher interest rates and a higher bill for servicing the government’s debt: fiscal watchdog the Office for Budget Responsibility estimates a one-point increase in inflation would add £7.3 billion to debt servicing costs in 2026-2027 alone.

The effect on businesses and home owners is also likely to be chilling. Britain’s banks are already repricing their most popular mortgages, which are tied to the two-year gilt rate. Hundreds of mortgage products were pulled in a hurry after the MPC meeting last week, something that will hit the housing market and depress Reeves’ intake from both stamp duty and capital gains.

Duncan Weldon, an economist and author, said: “Even if this were to stop tomorrow, the inflation numbers and growth numbers are going to look materially worse throughout 2026.

“If this continues for longer… it’s an awful lot more challenging and you end up with a much tougher budget this autumn than the government would have been hoping to unveil.”

Decision time

The U.K.’s economic plight presents an acute political headache for Starmer, as he faces a mismatch between his own party’s expectations about the government’s ability to help people and his own scarce resources.

Energy Secretary Ed Miliband has promised to keep looking at different options for some form of assistance to bill-payers hit by an energy price shock. A pain point is looming in July, when a regulated cap on energy costs is due to expire and bills could jump significantly.

One left-leaning Labour MP, granted anonymity to speak frankly, said: “They [ministers] need to be treating this like a financial crisis. They need plans for multiple scenarios with clear triggers for government support.”

A second MP from the 2024 intake said “it’s right that a Labour government steps in, particularly to help the most vulnerable.”

This demand for action is being felt in the upper echelons of the party too, as Culture Secretary Lisa Nandy recently argued Reeves’ fiscal rules — seen as crucial in the Treasury to reassure the markets — may need to be reconsidered if prices continue to rise and a major support package is needed. 

One Labour official said there are clear disagreements with Labour over how to go about drawing up help and warned “the fiscal approach is going to be a massive dividing line at any leadership election.” The same official pointed to recent comments by former Starmer deputy — and likely leadership contender — Angela Rayner about the OBR, with Rayner accusing the watchdog of ignoring the “social benefit” of government spending.

Despite the pressure, ministers have so far restricted themselves to criticizing petrol retailers for alleged profiteering, and have been flirting with new powers for markets watchdog the Competition and Markets Authority. The government said Reeves would on Tuesday set out steps to “help protect working people from unfair price rises,” including a new “anti-profiteering framework” to “root out price gouging.”

But Starmer signaled strongly in an appearance before a Commons committee Monday evening that he was not about to unveil any wide-ranging bailout package, telling MPs he was “acutely aware” of what it had cost when then-Prime Minister Liz Truss launched her own universal energy price guarantee in 2022. 

O’Neill backed this approach, saying: “I don’t think they should do much… They can’t afford it anyhow. The nation can’t keep shielding people from external shocks.”

Weldon predicted, however, that as the May elections approach and the energy cap deadline draws nearer, the pressure will prove too much and ministers could be forced to step in.

The furlough scheme rolled out during the pandemic to project jobs and Truss’s 2022 intervention helped create “the expectation that the government should be helping households,” he said.

“But it’s incredibly difficult. Britain’s growth has been blown off-course an awful lot in the last 15 years by these sorts of shocks.”