Middle East conflict increases longstanding challenges on retail and hospitality businesses

The conflict in the Middle East is forecast to weigh on the UK economy and exacerbate longstanding challenges for retail and hospitality businesses, according to the new EY UK Economic Outlook.

The analysis shows that, prior to the outbreak of the conflict in the Middle East, UK GDP was on track to grow by 1.3% in 2026. However, the disruption to global energy supply and subsequent effect on prices and inflation are now predicted to weigh on the UK’s economic momentum, slowing GDP growth to 0.8% this year.

GDP growth is then expected to rise to 1.2% in 2027, although this remains below the 1.4% that the UK was on track to achieve prior to the conflict.

The Outlook’s modelling is based on the Strait of Hormuz reopening by the end of Q2 2026, albeit with subdued levels of tanker traffic and a continued risk of disruption. However, if there is an escalation in the conflict and the strait remains closed until the end of 2026, the Outlook’s model suggests that UK GDP growth could fall to 0.3% this year.

The Outlook anticipates that increases to wholesale energy prices will fuel a rise in energy bills, driving UK inflation above 4% by the end of 2026. The Bank of England is now expected to hold the Bank Rate at 3.75% throughout the year, in contrast to the two reductions priced in by the market prior to the conflict. EY now forecasts that the next reduction in interest rates will occur in April and July 2027, with the Bank of England expected to implement two cuts of 25 basis points each before leaving the Bank Rate at 3.25% for the remainder of 2027.

Continued global economic uncertainty, heightened inflation and elevated interest rates are expected to weigh on demand and order books for businesses, prompting reductions or delays to some spending decisions. EY is forecasting flat UK business investment growth of 0% in 2026, which is then expected to rise to 2% in 2027 and 3% in 2028 as lower interest rates reduce the cost of capital.

Unemployment is forecast to increase slightly to 5.8% by the end of 2026 as weaker growth impacts hiring levels, before falling back to 5.5% within a year and reaching 5.2% in 2028.

Anna Anthony, EY UK & Ireland Regional Managing Partner, said “Businesses are continuing to grapple with the very real consequences of global volatility: turbulent energy prices, supply chain disruption, inflation and elevated interest rates. Making strategic investment decisions in this environment is challenging but critical as companies look to adapt, build resilience and continue to compete internationally.

“The UK has been a resilient market in recent years, but high electricity prices continue to put pressure on industrial businesses and limit investment appetite. The Government’s recent expansion of the British Industrial Competitiveness Scheme and commitment to diversifying the UK’s energy mix are welcome steps forward. Tackling these structural challenges will take time, but addressing energy costs and resilience offers an enormous opportunity to boost UK competitiveness by widening business margins and unlocking capital for those long-term investments at the heart of the Industrial Strategy.”

Energy supply pressures driven by the conflict in the Middle East are anticipated to have a particularly pronounced impact on companies that use substantial amounts of energy in producing materials, such as steel, plastic or chemical manufacturers, as well as the businesses that purchase these goods. This would exacerbate a longstanding UK challenge.

The UK’s industrial electricity prices have increased in recent years, climbing from the tenth highest in Europe in 2019 to the highest by 2024. EY analysis has determined that higher relative energy costs have already affected national growth and that the economic output of the UK’s energy intensive industries fell by 8% between 2019 and 2024, while all other industries grew by over 6%. The EY UK Economic Outlook suggests that had energy‑intensive industries kept pace with other sectors over this timeframe, UK GDP would have been £30bn higher in 2025.

EY modelling examined the long‑term impact of the current energy price disruption across UK sectors over a five‑to‑ten‑year horizon. The analysis shows that UK heavy manufacturing and energy utilities are expected to be most affected, with output 2.2% and 1.8% lower over the longer term respectively when compared to the previous baseline forecast, as labour and capital shift towards less energy‑intensive areas of the economy. In contrast, business services are projected to see marginally higher levels of output over the long term (0.08% higher than the previous baseline level) as resources are reallocated towards this sector.

Peter Arnold, EY UK Chief Economist, said: “Despite a relatively strong start to 2026, the conflict in the Middle East means the UK economy is once again being shaped by external shocks and on track for another year of subdued growth. We expect the first quarter of this year to show GDP on a fairly promising trajectory, before flatlining in the second quarter and gradually recovering into 2027 as the global markets adjust. Energy supply constraints will push inflation higher and delay interest rate cuts, increasing the cost of borrowing for businesses and prompting some companies to reassess spending decisions.

“Industrial and consumer-facing businesses are particularly exposed to the effects of energy volatility. High electricity prices were already constraining UK economic output last year, and further energy market disruption will intensify this pressure. Cautious levels of consumer spending seen since the pandemic also now appear more structural than temporary, with all income groups reallocating household spending towards savings and essentials and away from discretionary spending. This is a concerning trend for consumer-facing sectors and will likely be exacerbated by ongoing global uncertainty and the predicted rise in inflation.”