EY Item Club Warns UK Could 'Flirt With Recession' as Iran War Drives Energy Costs Higher
The UK economy is showing increasing signs of stagflation — the toxic combination of rising prices and stagnating growth — as consumer confidence fell to a two-year low of -25 in April, payroll numbers dropped by 11,000 in March, and the EY Item Club warned that the country could "flirt with recession" as energy prices driven by the Iran war continue to squeeze households and businesses alike.
Background
Stagflation is the economic condition that policymakers fear most, because it presents a dilemma that conventional tools cannot easily resolve. Raising interest rates to control inflation risks deepening the economic slowdown; cutting rates to stimulate growth risks allowing inflation to become entrenched. The UK experienced a mild version of this dilemma in 2022-23, when post-pandemic supply chain disruptions and the energy shock from Russia's Ukraine invasion pushed inflation above 11%. The economy navigated that period without a technical recession, but the scars — in the form of higher mortgage costs, depleted household savings, and weakened business investment — have never fully healed.
The Iran war, which began earlier this year, has delivered a fresh energy shock. Oil prices have surged above $100 per barrel as disruption to the Strait of Hormuz — through which approximately 20% of the world's oil passes — has tightened global supply. UK inflation rose to 3.3% in March, driven by an 8.7% year-on-year increase in fuel prices. Food inflation is projected to reach 9-10% in 2026 as higher energy costs feed through supply chains. The Iran conflict is projected to reduce the UK's fiscal buffer by up to £16 billion, increasing borrowing and the likelihood of future tax rises.
The FTSE 100, which hit a record high of over 10,000 points in January 2026, has since lost momentum and was trading around 10,402 on 27 April — a reflection of the mixed signals coming from the UK economy. The index's composition, with many companies generating significant revenue overseas, means its performance is not a direct measure of domestic economic health.
Key Developments
Consumer confidence fell to -25 in April — the third consecutive monthly decline and the lowest reading in two years. The decline reflects growing concerns about inflation, interest rates, and the Middle East conflict, leading households to cut spending and increase borrowing. Payroll numbers fell by 11,000 in March, the largest monthly drop since November, as rising energy and wage costs deter hiring. Vacancies have fallen to near five-year lows.
UK firms now anticipate inflation to reach 4% over the next year, according to surveys, while the EY Item Club has warned that growth could halve and unemployment could rise to 5.8% by 2027 — potentially pushing the jobless total above 2 million. The tax burden on the UK is expected to rise significantly, potentially exceeding 40% of GDP, as the government struggles to maintain public services while managing higher borrowing costs.
In the retail sector, sales saw a 0.7% rise in March, boosted by fuel stockpiling and clothing sales, but retailers continue to face rising energy and supply chain costs. TG Jones is undergoing restructuring that could lead to up to 100 store closures. In the property market, prime London sales are down 37% as affluent investors withdraw from UK property due to high taxes and poor returns.
Why It Matters
The stagflation risk is not merely an economic abstraction — it has direct consequences for millions of households across the UK. Higher inflation erodes the real value of wages and savings; slower growth means fewer job opportunities and reduced public services. The combination is particularly damaging for those on lower incomes, who spend a higher proportion of their income on energy and food — the two categories where price rises have been most severe.
For the government, the economic outlook complicates an already difficult political situation. The Chancellor's fiscal rules — which require debt to be falling as a share of GDP — are under pressure from higher borrowing costs and reduced tax revenues. Unlike the 2008 crisis, when the government had significant fiscal headroom to respond with stimulus, the current situation leaves relatively little room for manoeuvre. The Bank of England's next interest rate decision will be watched closely for any signal that relief is coming.
Local Impact
The economic pressures are being felt across every part of the UK and Ireland. In Northern Ireland, where the economy is more dependent on public sector employment than the UK average, the combination of higher inflation and potential public spending cuts is particularly concerning. In Scotland, more SMEs are resorting to short-term borrowing to manage cashflow. In Wales, where manufacturing and agriculture are significant employers, rising energy costs are squeezing margins. For Irish businesses trading with the UK — still the Republic's largest single trading partner — a UK recession would have direct consequences for export revenues and employment.
What's Next
The Bank of England's Monetary Policy Committee meets in May, and its decision on interest rates will be the most closely watched economic event of the month. The Office for National Statistics will publish updated GDP figures in the coming weeks, which will provide the first clear picture of how the economy performed in the first quarter of 2026. Watch also for the government's response to the EY Item Club's recession warning — any emergency fiscal measures would need to be announced quickly to have an impact on business and consumer confidence before the summer.
Sources: CPA Credit Protection Association, BBC News
