The UK government could be forced to borrow tens of billions more than expected as the economic fallout from the Iran war begins to take hold. Early projections suggest a sharp shift in fiscal conditions despite recent improvements in borrowing figures.
Official data shows borrowing fell in the last financial year, offering short-term relief to the Treasury. Yet economists warn that rising energy costs, inflation pressures and labour market strain could quickly reverse that trend in the year ahead.
Energy Shock and Rising Costs Threaten Fiscal Stability
Government borrowing totalled £132 billion in the year to March, nearly £20 billion lower than the previous year and slightly below forecasts. According to the Office for National Statistics, March borrowing alone reached £12.6 billion, marking the lowest figure for that month since 2022, though still higher than expected.
This relative improvement may prove temporary. Economists point to the economic shock linked to the Iran war, particularly through higher energy prices, as a key risk to public finances. Elliott Jordan-Doak, senior UK economist at Pantheon Macroeconomics, said the outlook for 2026/27 appears “more daunting”, suggesting current gains could fade.
Higher fuel prices are already affecting households and businesses, while also generating increased VAT revenues for the Treasury. There are also expectations of additional income from windfall taxes on North Sea energy producers. However, these gains may be outweighed by broader economic damage, including reduced tax receipts from slower growth.
The government is also under pressure to provide support for low-income households and energy-intensive industries facing rising costs. This could further strain public spending at a time when fiscal flexibility is limited.
Labour Market Strain and Debt Costs Add to Pressure
Beyond energy, the labour market is emerging as another source of concern. According to Michael Saunders of Oxford Economics, UK unemployment could rise by 150,000 this year as businesses respond to higher costs. A rise in job losses would increase welfare spending while reducing income tax revenues, compounding fiscal challenges.
At the same time, borrowing costs have risen. Yields on UK government bonds recently reached 5% for the first time since 2008, reflecting market concerns and broader global uncertainty. Although debt interest payments in March were £3.2 billion, down from a year earlier due to lower inflation at the start of the year, this trend may not continue.
According to the data, total debt interest payments over the full year reached £97.6 billion, the second highest level on record. Economists expect this figure to increase as inflation rises again, partly driven by the energy shock linked to the conflict.
Thomas Pugh, chief economist at RSM UK, said borrowing this year could be £30 billion higher than pre-war forecasts. He noted that if the increase proves temporary, it may not require immediate tax rises. Yet other analysts suggest tax measures remain a likely option to stabilise public finances.
The Treasury maintains that its strategy is working. Chief Secretary James Murray stated that the deficit has fallen by £19.8 billion, attributing this to government efforts to reduce borrowing while maintaining economic stability in a volatile environment.
