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.
EY 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.
Consumer spending is predicted to grow by 0.3% in 2026, compared to the 0.9% growth the UK had been on track to achieve prior to the Middle East conflict. This is expected to be followed by 1.5% growth in consumer spending in 2027 and 2.2% in 2028.
GDP growth is forecast 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.
Increases to wholesale energy prices are anticipated to 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.
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.
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.
“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.”
Risk for consumer-facing sectors as spending shifts to essential over discretionary
Heightened economic uncertainty and household caution continue to weigh on spending decisions, even as incomes rise. The Outlook highlights that discretionary spending is likely to bear the brunt of this trend, compounding the challenging market conditions that many businesses in consumer-facing sectors have contended with since the pandemic.
EY analysis suggests that the average UK household, with annual disposable income of around £36,700, has increased its savings rate from 7% in 2019 to 9% today, while the proportion of spending dedicated to ‘essential’ purchases in categories such as household energy, mortgages and rents has risen from 46% to 49%. This has caused the proportion of income allocated to discretionary spending to fall from 47% to 42%.
Had this proportion remained at 47%, The Outlook indicates that UK households would today be spending an additional combined £78bn across discretionary purchases in categories such as clothing and footwear, restaurants and hotels, and recreation and culture.
Higher income households, which make up a disproportionate share of consumer spending, has also shifted. The top two income quintiles, with median disposable incomes of at least £48,355, account for 56% of total UK consumer spending. Since 2019, the highest income quintile has raised its savings rate from 10% to 13%, while discretionary spending has declined from 50% to 44%. The second highest income quintile has increased savings from 8% to 9% over this time, while discretionary spending has fallen from 48% to 45%.
Silvia Rindone, EY UK&I Retail Lead, added: “UK consumers are contending with another global economic challenge that will squeeze household budgets and reinforce cautious spending patterns that have persisted since pandemic. These global pressures sit outside retailers’ control, but their impact on footfall, margins and investment capacity is very real. Disruption to shipping routes and energy supply is already pushing up costs across international networks, and further cost-of-living increases are limiting both demand and retailers’ ability to invest in growth and innovation.
“In this environment, retailers that adapt quickly are best placed to navigate uncertainty. Prioritising consumer-focused, value‑driven propositions, strengthening trust and delivering personalised experiences will be critical to maintaining relevance.”
How consumer spending in specific categories has shifted
The rising prices of household energy, mortgages and rents since 2022 are driving a larger share of income being dedicated to essential spending. EY analysis shows that nominal spending on electricity, fuel and other utilities has risen by 41% since 2019. Mortgage interest payments have also increased sharply, rising by 28%, while rentals and housing nominal spending has grown by 20%.
In contrast, EY identifies substantial real-term declines in discretionary categories, suggesting that in tight economic conditions households are spending less cash on these items (nominal spending) and also purchasing lower volumes (real spending). This is particularly pronounced in clothing and footwear (17% drop in nominal terms, -30% fall in real terms), restaurants and hotels (-11% in nominal, -30% in real), and food and non-alcoholic drinks (-8% in nominal, -9% in real).
The recreation and culture category has seen 3% growth in nominal spending but a 13% fall in real spending, indicating that price increases may be prompting households to spending higher amounts in this area, but they are purchasing less frequently.