UK public finances: what the experts say
City economist are warning that UK government borrowing is set to be driven higher by the Iran war, following this morning’s (small) drop in the annual deficit in the last financial year:
Lindsay James, investment strategist at Quilter, says:
“The conflict in the Middle East has shown the UK economy remains very exposed to geopolitical shocks. However, there are some encouraging signs that rigid fiscal rules have been having the desired effect thus far, as today’s public sector finance data shows borrowing was £12.6 billion in March. This is £1.4 billion less than the same month last year, and the lowest March reading since 2022.
“Borrowing had been expected to be lower this year as the government had front loaded a lot of its spending plans into its early years, but things could get more difficult from here on out. With inflation on the rise, debt interest climbing again and gilt yields also becoming elevated once more, the fiscal headroom Chancellor Rachel Reeves had established could very quickly run out once again. As such, tax is likely to feature prominently as the lever to pull to help keep the public finances on steady ground, and we have already seen the burden this places on growth.
Ruth Gregory, deputy chief UK economist at Capital Economics, warns that borrowing will probably rise in the current financial year (April to next March).
March’s figures showed an unexpected undershoot of the OBR’s forecast for public borrowing in 2025/26. But we do not expect this improvement to last long. We think the energy price shock will mean that borrowing overshoots the OBR’s forecast by a huge £29bn for the 2026/27 fiscal year and by about £13bn in subsequent years.
Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK, predicts that March could be the last month of good news on borrowing for a while:
“The good news for the Chancellor is that full year borrowing for 2025/26 came in at £132.bn, down from £151.9bn in the previous financial year, and in line with the latest OBR forecast. The bad news is that the war in Iran means the situation will deteriorate sharply over the rest of this year. That will limit her ability to offer households and businesses a significant bailout if energy prices move higher.
“Looking ahead, March will probably be the last month of good news on borrowing. Gilt yields are down from their 5% peak in March, but are still significantly higher than before the war. Borrowing costs will rise quickly from here though, as higher interest payments on index-linked gilts weaken the near-term fiscal position. At the same time, the economy will almost certainly slow, which could send the unemployment rate trending back up. That would lower income tax receipts and raise welfare spending.
Key events
FTSE 100 at two-week low
The London stock market has fallen further into the red after this morning’s PMI report showed UK firms were being hit by sharp cost rises.
The FTSE 100 is now down 107 points, or 1%, at 10,369, its lowest in just over two weeks.
Derren Nathan, head of equity research at Hargreaves Lansdown, says the PMi survey knocked shares lower:
The S&P Flash UK PMI for April showed an upturn in both services activity, which reached a two-month high of 52.0, and manufacturing, which was the strongest print in 47 months at 53.6. But there’s a major caveat.
Much of this increased momentum comes from a dash to lock in purchases, on fears of price rises and supply chain disruption from the war. An underlying decline in business confidence and a weak outlook for the labour market tallies with our view that Bank of England lending rates are likely to hold steady until firm progress towards the end of the Iran war is made. The FTSE 100 is down circa 50 points further following the release.
Asos moving some production to UK to avoid supply chain disruption
Sarah Butler
Asos is shifting more production closer to home – to Turkey, Morocco and even the UK – as it tries to offset disruption to shipping caused by the Middle East conflict.
José Antonio Ramos Calamonte, the chief executive of the online fashion retailer, said the group had seen an increase in freight costs and longer delivery times as a result of the conflict which has pushed up fuel prices but he said:
“We are navigating the cost impact through flexibility of different [manufacturing] origins and shipping methods.”
He said the group had already been moving some production from the Far East before the conflict began but that had stepped up so that now about a third of its clothing was made closer to home including Turkey, Morocco and the UK.
“We were ahead of the curve,” he said.
Calamonte said that so far there had not been inflation on costs but if the conflict continued then the price of Polyester was likely to rise but prices of other fabrics such as cotton were coming down. He said there were so many factors at play that the outlook on price was currently “a bit vague”.
Asos said on Thursday that sales fell 9% to £1.17bn in the half year to 1 March but pre-tax losses narrowed to £138m from £241.5m a year before as it shifted away from heavy discounting. Shares in Asos rose 1.3% in morning trading as the company said it attracted 9% more new customers in March, the first month of growth since September 2021.
Asos also said it was pursuing a £7m refund of US tariffs after courts ruled the levies should not have been imposed.
The surge in cost pressures hitting UK companies adds to the dilemma facing the Bank of England, which is due to announce its next decision on interest rates in a week’s time.
Chris Williamson, chief business economist at S&P Global Market Intelligence says:
The UK economy has gathered some renewed momentum in April after the initial impact of the war in the Middle East caused growth to stall in March, but the upturn comes with a catch. The improved rate of expansion is in part a reflection of a short-term boost from a rush to secure purchases ahead of feared price rises and supply shortages linked to the war.
Prices have spiked higher at a rate not previously seen by the survey outside of the pandemic, suggesting inflation could rise more than many forecasters have been anticipating. Prices are rising not just because of surging energy costs, but also due to increases in charges levied for a wide variety of goods and services, with price hikes often stoked by supply concerns. The number of supply delays reported has jumped to the highest on record if the pandemic is excluded.
Business confidence and employment have also been dragged lower by the ongoing conflict, boding ill for growth to weaken in the coming months just as price pressures intensify.
The survey highlights the difficult choices facing policymakers at the Bank of England. The spike in price pressures will add to calls for rate hikes to dampen inflation, but the Bank will need to carefully assess the degree to which economic growth might weaken. While April’s PMI is indicative of the economy rebounding from a flat picture in March to a 0.2% quarterly growth rate, the details of the survey hint strongly that this pace cannot be sustained should the crisis persist.”
Biggest jump in UK service sector cost inflation since at least 1996
Ouch! UK services sector companies have been hit with the biggest jump in cost inflation in at least 30 years, as the Iran war drove up petrol and diesel prices.
A survey of purchasing managers at British firms has shown that service providers experienced a surge in cost pressures, this month, largely due to higher fuel prices.
The acceleration in service sector cost inflation since March was the greatest for a single month since the data began being tracked in July 1996.
This follows yesterday’s inflation report, which showed that fuel prices pushed up costs in March.
Data provider S&P Global also found that overal input cost inflation this month has hit the highest level since November 2022, driven by a rapid increase in raw material prices in the manufacturing sector.
The report says:
Manufacturing production returned to growth in April, following a marginal decline in the previous month. A number of firms suggested that customers had brought forward orders and sought to build safety stocks in the expectation of rising prices and supply constraints.
That said, there were also some reports that raw material shortages and international shipping disruptions had weighed on production volumes in April.
Overall, the flash UK PMI composite output index rose to 52.0 in April, up from 50.3 in Mach (where 50 points shows stagnation).
However, it also found that business optimism at UK private sector firms fell to its lowest since last April, when Donald Trump’s trade war hit confidence.
Eurozone private sector contracting as Middle East conflict pushes up prices
Economic output across the eurozone has fallen for first time in 16 months, as the Iran war drove up prices.
Data provider S&P Global has reported that the eurozone private sector dipped into contraction in April, pulled down by a contraction in the services sector.
Its flash Eurozone PMI Composite Output Index has dropped to 48.6 in April, down from 50.7 in March.
The report also found that inflationary pressures strengthened again this month, with both input costs and output prices rising at the sharpest rates in more than three years.
The war also caused severe supply-chain disruption, with manufacturers seeing suppliers’ delivery times lengthen to the greatest extent since mid-2022. Meanwhile, business confidence waned and employment fell marginally, S&P Global adds.
Sheena McGuinness, co-head of energy and natural resources at RSM UK, says the drop in UK fuel duty revenues last month is part of the longer-term shift to electric vehicles, adding:
“With the ongoing conflict in Iran causing concerns over fuel shortages and spiking prices, the downtick may also be driven by consumers beginning to limit their vehicle usage to necessary journeys.”
The UK’s revenue from fuel duty fell to £1.8bn in March, the lowest for any month since July 2023, Reuters has spotted.
They explain:
While representing only a fraction of government revenue, the drop in fuel duty in response to higher prices for petrol and diesel could be an early warning sign of how the war might weaken activity across the economy and hit overall tax revenues.
European gas prices up
Gas prices have risen this morning too.
UPDATE: The month-ahead UK wholesale gas contract is up 4.8% at 113.7p per therm, its highest in over a week.
Before the Iran war began at the end of February, UK gas was trading below 80p a therm, but rose as high as 180p/therm in March.
UPDATE: European gas prices are up 4.3% too, to €45.4 per megawatt hour.
Looking ahead, analysts at Unicredit fear that European gas prices will face upside pressure in the coming months.
Unicredit told clients:
Europe needs to import around 54bcm to replenish its gas stocks before the 2026-27 winter heating season begins. While this had previously looked feasible in light of an estimated 45bcm in new LNG [liquefied natural gas] capacity that was expected to come online in 2026, this supply-growth forecast is being continually revised downward.
Not only is Qatar’s planned expansion unlikely to materialise in 2026, the blockade of the Strait of Hormuz also removes around 8bcm monthly from global supply and approximately 17% of Qatar’s capacity will reportedly be offline for several years due to war damage.
London stock markets opens lower
The deadlock in the Middle East is weighing on the London stock market this morning.
The FTSE 100 index of blue-chip shares has dropped by 54 points, or 0.5%, in early trading, to 10,422 points.
Sainsbury’s (-5%) are among the top fallers after their warning about the impact of the Iran war.
The FTSE 250 index of medium-sized companies is down 0.75%. WH Smith (-11%) is leading the sell-off here, after it cut its profit forecast this morning.
UK debt/GDP ratio at six-year low
The best way to look at government national debt is to compare it to the size of the economy – and here the picture is encouraging.
The £132bn which the UK borrowed in the financial year ending in March (see opening post) works out at 4.3% of gross domestic product (GDP).
That’s 0.9 percentage points less than in the year to March 2025 and is a six year low – the lowest since the year to March 2020( when it was 2.6% of GDP) just before the Covid pandemic drove up borrowing.
However, as flagged at 7.28am, economists are warning that the Iran war will drive UK borrowing higher, and slow growth, meaning that debt/GDP ratio may rise in the current financial year.
Sainsburys, Foxtons and WH Smith all warn of impact of Iran war
More UK companies are warning this morning that the Iran war will hurt their businesses.
Supermarket chain J Sainsbury told the City that it is ‘very unclear’ what the impact will be, saying:
The conflict in the Middle East will impact both our customers and our business. The duration and extent of these impacts is very uncertain and this is reflected in our profit guidance, where we currently expect to deliver Total underlying operating profit of between £975 million and £1,075 million. We continue to expect to deliver Retail free cash flow of more than £500 million.
Estate agent Foxtons also reported a negaive impact, with CEO Guy Gittins explaining:
“The Sales market remains subdued and has been further affected by recent events in the Middle East, which have tempered buyer sentiment and impacted mortgage rates and availability. As ever, Foxtons is focused on what we can control by managing costs, increasing efficiencies and repositioning our Sales business to mitigate the impact of the market.
And WH Smith, which operates at transport hubs, has lowered its profit forecast and said it was “taking a more cautious outlook” due to the impact of the conflict on passenger numbers and consumer morale.
It says:
In light of the uncertainty arising from the conflict in the Middle East, the Group is taking a more cautious outlook reflecting the impact on passenger numbers and weaker consumer confidence. At this stage, the Group expects to deliver FY26 Headline Group profit before tax and non-underlying items of £90m – £105m.
UK public finances: what the experts say
City economist are warning that UK government borrowing is set to be driven higher by the Iran war, following this morning’s (small) drop in the annual deficit in the last financial year:
Lindsay James, investment strategist at Quilter, says:
“The conflict in the Middle East has shown the UK economy remains very exposed to geopolitical shocks. However, there are some encouraging signs that rigid fiscal rules have been having the desired effect thus far, as today’s public sector finance data shows borrowing was £12.6 billion in March. This is £1.4 billion less than the same month last year, and the lowest March reading since 2022.
“Borrowing had been expected to be lower this year as the government had front loaded a lot of its spending plans into its early years, but things could get more difficult from here on out. With inflation on the rise, debt interest climbing again and gilt yields also becoming elevated once more, the fiscal headroom Chancellor Rachel Reeves had established could very quickly run out once again. As such, tax is likely to feature prominently as the lever to pull to help keep the public finances on steady ground, and we have already seen the burden this places on growth.
Ruth Gregory, deputy chief UK economist at Capital Economics, warns that borrowing will probably rise in the current financial year (April to next March).
March’s figures showed an unexpected undershoot of the OBR’s forecast for public borrowing in 2025/26. But we do not expect this improvement to last long. We think the energy price shock will mean that borrowing overshoots the OBR’s forecast by a huge £29bn for the 2026/27 fiscal year and by about £13bn in subsequent years.
Thomas Pugh, chief economist at audit, tax and consulting firm RSM UK, predicts that March could be the last month of good news on borrowing for a while:
“The good news for the Chancellor is that full year borrowing for 2025/26 came in at £132.bn, down from £151.9bn in the previous financial year, and in line with the latest OBR forecast. The bad news is that the war in Iran means the situation will deteriorate sharply over the rest of this year. That will limit her ability to offer households and businesses a significant bailout if energy prices move higher.
“Looking ahead, March will probably be the last month of good news on borrowing. Gilt yields are down from their 5% peak in March, but are still significantly higher than before the war. Borrowing costs will rise quickly from here though, as higher interest payments on index-linked gilts weaken the near-term fiscal position. At the same time, the economy will almost certainly slow, which could send the unemployment rate trending back up. That would lower income tax receipts and raise welfare spending.
Oil over $100 as strait of Hormuz remains blockaded
The oil price is rising above $100 a barrel this morning, as supplies through the strait of Hormuz remain badly disrupted by the Iran war.
Yesterday, Iranian forces have seized two ships in the crucial waterway as the US and Iran both doubled down on imposing separate blockades of the shipping waterway.
Mohammad Bagher Ghalibaf, the speaker of the Iranian parliament and lead negotiator, said late on Wednesday that reopening the strait of Hormuz would be “impossible” while the US and Israel committed “flagrant” breaches of the ceasefire, including the US naval blockade, “the hostage-taking of the world’s economy” and “Zionist warmongering”.
The deadlock has raised doubts about whether stalled peace negotiations will resume.
Brent crude is up almost 1% this morning at $102.80 a barrel.
Introduction: UK borrowing undershoots forecasts
Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.
Britain’s government borrowing has dropped in the first full fiscal year of the Labour government, and slipped in slightly below forecasts.
New data from the Office for National Statistics this morning shows that the UK borrowed £132bn in the financial year ending in March – almost £20bn less than in the previous financial year to March 2025.
That’s also £700m less than the £132.7bn forecast by the Office for Budget Responsibility (OBR) for the financial year.
Both income tax and VAT brought in more revenue than the OBR expected, while Public sector spending was lower than forecast.
The resulting borrowing undershoot might cheer chancellor Rachel Reeves – who will be at the London Stock Exchange this morning for the official launch of the Retail Investing Campaign – except that the Iran war is now threatening her fiscal plans.
As Martin Beck, Chief Economist at WPI Strategy, explains:
“Public sector borrowing was down on a year-on-year basis in March, leaving the full-year deficit broadly in line with the Office for Budget Responsibility (OBR)’s forecast.
But the OBR’s expectation that borrowing will continue to fall this year will be challenged by the fallout from the conflict in the Middle East. For now, however, the implications for the government’s fiscal rules remain limited.
In March alone, the ONS reports, the UK borrowed £12.6bn to cover the gap between public sector spending and income – £1.4bn less than a year ago, and the lowest March borrowing since 2022.
The agenda
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7am BST: UK public finances for March
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7:30am BST: UK’s retail investment campaign launches at London Stock Exchange
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9am BST: Eurozone ‘flash’ composite PMI for April
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9.30am BST: UK ‘flash’ composite PMI for April
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11am BST: CBI industrial trends report
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1.30pm BST: US initial jobless claims
