The Institute of Fiscal Studies (IFS) warned that if the war in the Middle East drags on, it will be unambiguously bad news for the Chancellor. The IFS said the Treasury will be forced to provide financial support to struggling households as the cost of energy rises, blowing a hole in Chancellor Rachel Reeves’s plans to control the nation’s debts. Tax revenues are also likely to fall as panic in the stock market leads to lower share prices and declining capital gains tax payments, according to the IFS. However, the gloomy scenario could be avoided if the conflict ends quickly.
Government borrowing figures released by the Office for National Statistics (ONS) show a mixed picture. The government racked up the highest February borrowing on record outside of Covid at £14.3 billion, far more than analysts had expected. The ONS said public sector borrowing was £2.2 billion higher last month than in February 2025, while most economists had pencilled in borrowing of £8.8 billion. Tom Davies, ONS senior statistician, said borrowing was higher than the same month last year and was the second-highest February figure on record overall, but the highest outside of the pandemic. Some of the deterioration was down to debt interest being paid at the beginning of February rather than the end of January, as a result of when the weekend fell. January had seen the government enjoy a large surplus. Central government raked in £1,016.7 billion in revenues with one month left in the financial year, £79 billion more than the equivalent period in 2024-25. Some £32.7 billion of that was extra income tax, £7.6 billion VAT, and £4.3 billion Corporation Tax. But spending was up £65.2 billion, including £20 billion extra on social security and a £13.5 billion rise in debt servicing costs. Bumper spending and debt interest payments outweighed a spike in revenues from Labour's huge tax raids.
Borrowing was higher than the same month last year and was the second-highest February figure on record.
Despite the February spike, the full-year borrowing figures were more positive. The ONS estimated public sector borrowing dropped £19.8 billion, or 13.1%, to a lower-than-expected £132 billion in the 12 months to the end of March, helped by rising tax receipts from last April’s labour tax hike. The outturn was £700 million below the £132.7 billion forecast by the Office for Budget Responsibility (OBR) and the lowest since 2022-23. Borrowing in the financial year was estimated at 4.3% of GDP, the lowest level since 2019-20. Tom Davies noted that borrowing was almost £20 billion lower than in the previous financial year and broadly in line with the OBR's forecast. However, the picture is likely to shift dramatically in the coming months with the Iran war expected to fuel inflation and squash economic growth. Debt interest costs fell in March but rose over the full year to £97.6 billion, the second highest annual level on record. Central government tax receipts increased by £54.7 billion to £845.4 billion over the 12 months, with the notorious hike in employer National Insurance seeing social contributions rise by £33 billion to £206.8 billion. Meanwhile, central government departmental spending on goods and services increased by £27.9 billion to £461.6 billion, driven by pay rises and inflation. Benefits paid by central government increased by £20.7 billion to £327.3 billion, largely due to upratings including to state pensions. Since becoming Chancellor in July 2024, the OBR's historical database shows Ms Reeves has imposed an astonishing £75 billion a year of extra tax on Britons.
The impact on households and markets is already being felt. Gas prices were up almost 80% compared to Friday, and the FTSE 100 stock index rallied following sharp falls but remains 2% down compared to last week. Markets suggest interest rates could now rise in the coming months, after the Bank of England warned over the impact of soaring oil and gas prices in the wake of the US-Israeli strikes. Drivers are already feeling the pain at pumps, and energy bills are in line to rise by more than a fifth when the cap changes in July. Energy bills are poised to fall from April due to measures in the autumn budget, then forecast to rise to nearly £2,000 in July. The shock has led to higher oil, gas, and fertilizer prices, triggering concerns about food security and job losses. Fuel and fertilizer prices may remain high for a prolonged period due to infrastructure damage. Shortages of key inputs will hurt industries including energy and food, and the war has displaced people and reduced travel and tourism. However, pensioners could benefit from potentially improved annuity rates, as the level of guaranteed income available to retirees could be increased.
Borrowing was almost £20 billion lower than in the previous financial year, and broadly in line with the OBR's forecast.
The government has outlined its response and contingency planning. Prime Minister Sir Keir Starmer said the Government is watching the impact on households, while Ms Reeves has held meetings with energy firms. The UK did not start or join the war, Reeves said, but struck a joint agreement with 10 other major economies calling for a negotiated resolution and avoiding unnecessary trade restrictions. The UK also announced a third tranche of Extraordinary Revenue Acceleration funding for Ukraine's defences. The Prime Minister convened a summit with the President of France to support freedom of navigation through the Strait of Hormuz, and the UK is engaging with the insurance industry to support shipping when conditions allow. Reeves extended the 5p cut for fuel duty twice since the election, saving the average motorist £90 a year, froze prescription charges for two years, and froze rail fares for the first time in 30 years. She is taking £150 off energy bills with additional help for those struggling with heating oil, and expanded the British industrial competitiveness scheme to over 10,000 manufacturers. Reeves said the previous government's universal energy support saw more than a third of direct bill support go to the wealthiest households, and she has no intention of repeating the across-the-board subsidies introduced by Liz Truss in 2022, which cost about £40 billion. The IMF said Reeves' plan is 'the appropriate response' to the conflict. However, Reeves stopped short of announcing specific immediate support but said she was contingency planning. She hinted that any support may not come into effect until the autumn. Reeves said officials have been working with DWP and local authorities to assemble data for more targeted support. The government warned it will not allow companies to take advantage of the crisis by short-changing consumers, and Reeves said she would ensure the CMA has powers to stop profiteering. She also said she would meet supermarket and bank bosses to ensure they help consumers.
Uncertainties and unknowns remain. The duration of the conflict is unpredictable, and defence insiders admit it is not clear how long it will last. The current crisis is different from the 2022 energy crisis because it primarily surrounds oil supply and has wider impacts on global trade. Some Asian countries are facing shortages and taking measures to reduce energy use. The UK has not experienced immediate supply disruptions but may face a jet fuel crunch. Even if the ceasefire becomes permanent, oil and gas supply will still be affected for some time due to infrastructure damage. Shipping through the Strait of Hormuz is yet to normalize, and it will take time for supplies to return to pre-conflict levels. The IMF, IEA, and World Bank warned the war has a 'substantial, global, and highly asymmetric' impact. Some oil and gas producers in the Middle East have seen a dramatic loss of export revenue. The Resolution Foundation warned over a potential £16 billion surge in government borrowing by 2029-30 due to the Middle East conflict, and that the Chancellor’s £23.6 billion headroom on her fiscal rules was at risk of being cut by nearly three quarters if the Iran war is prolonged.