What happens in the Persian Gulf will be crucial for the path of inflation in the UK over the next 12 months. The most desirable outcome will happen if the peace deal holds, the Strait of Hormuz is re-opened and remains open, and the damage to energy infrastructure in the region is limited.
The UK inflation rate remained at 2.8% in the year to May, according to the latest data from the Office for National Statistics (ONS). What’s more, the rate has been on a broad downward trend since July 2025, when it stood at 3.8%.
This trend is misleading. Prior to the Israeli/US attack on Iran at the end of February, the consensus was ‘Inflation expected to fall to 2% by April’, as I reported in my monthly blog post for the National Institute of Economic and Social Research (NIESR). But the impact of the closure of the Strait of Hormuz and the Middle East hostilities in general were quick to manifest themselves: monthly inflation in both March and April averaged 0.7%, implying an annualised rate of over 6%.
The monthly figure for May is much more normal at 0.2%: an annualised rate of 2.4%. But the main impact on energy prices has been delayed to the Ofgem (Office of Gas and Electricity Markets) price cap rise in July, which on its own will cause an increase in the consumer price index (CPI) of 0.7%.
Looking forward, the main uncertainty continues to be geopolitical. The ‘peace deal’ signed last week by the Iranian and US governments is really just a memorandum outlining a framework for serious detailed negotiations to begin. So, to discuss the future we need to consider alternative scenarios: what I’m calling the good, the bad and the ugly.
How has inflation responded to the Middle East conflict?
The behaviour of inflation in the first months since the start of the conflict can be interpreted as the initial ‘impact effect’ of the closure of the Strait of Hormuz: the reduction by 20% of the world’s supply of oil. The longer-run effects depend on how long the strait remains closed and how much of the energy infrastructure in the region was destroyed during the conflict.
Re-opening the strait and restarting the flow of oil and its transport represent both a technical and logistical matter. The production of oil needs to be restarted, together with that of liquid natural gas (LNG), alongside the supply chains underlying their transport, refining and distribution.
We can think of this as being analogous to restarting supply chains after the Covid-19 lockdowns in 2020. The strait has been closed for over three months now, and even if Iran and the United States end their dual blockade under the deal, it will take many months to get back to normal. Industry estimates vary, but they are in the range of six to 12 months.
On the infrastructure side, we do not know the extent of damage to the oil and LNG infrastructure in Iran and the Gulf states. Fortunately, the United States was restrained here and did not trigger the likely Iranian response, so much of the energy infrastructure probably remains intact. The ceasefire that commenced on 8 April was violated by both sides, but it was successful in preserving the energy infrastructure from further damage.
Reconstructing and repairing the infrastructure that was destroyed will have a longer time-scale, possibly several years. But the destruction would need to be very significant to have a major effect on the global oil supply: if we take as our baseline that 20% of the oil comes from the Persian Gulf, and if 20% of that capacity was destroyed, that would be a reduction by 4% of the world oil supply.
That’s not insignificant, but it could probably be partially made up with oil from other sources, such as Russia.
Three alternative scenarios for inflation
In light of these factors, we can consider three alternative scenarios for inflation: the good, the bad and the ugly. I illustrate these using the method employed in my monthly NIESR blog, which provides a way of forecasting inflation over the 12-month period from the latest inflation figure. This means that since we now have May 2026, we can make predictions up to May 2027.
The good
In this scenario, the Strait of Hormuz is re-opened and remains open. The damage to energy infrastructure in Iran and the Gulf is limited.
In the good scenario, the fact that the energy infrastructure is largely intact means that once the restarting of production and the supply chain issues are sorted, we will be back to an oil price similar to what there was before the Israeli/US attack.
But even in the good scenario, the fact that the strait was closed for over a quarter will pose problems in the coming months. Energy inventories are at historic lows, and the flow of oil and LNG will not resume to scale for several months. Energy shortages are almost inevitable in the third and possibly fourth quarters of 2026, and prices may well increase further or remain elevated before they start to come down.
But once the oil and LNG start to flow at more normal rates, prices will come down and we can expect inflation to subside soon after. If we take an optimistic view of a six-month adjustment period, then we can expect inflation to fall in the first or second quarter of 2027.
The bad
In this scenario, the Strait of Hormuz is re-opened and remains open, but the damage to the energy infrastructure is extensive.
The difference between the good and the bad scenarios is that the medium term is different. Even when the oil and LNG start flowing, there is less of it for a period of years. This means that oil prices will remain higher and so the decline in inflation will be slower.
Note that a sustained higher price of oil will not cause a permanent increase in inflation (it is a relative price shift). But the fact that the oil price does not fall will mean that downward pressure on inflation will be absent.
The ugly
In this scenario, the Strait of Hormuz remains closed.
In many ways, the domestic pressures within Iran and the United States make a mutually agreeable deal difficult. Israel also has a different cost-benefit calculus to the United States: any peace without removing the ‘threat’ of Iran being difficult to accept for the Israeli government. These factors may mean that the hostilities resume and that the strait remains closed for a prolonged period.
If the strait remains closed for most of 2026, then the supply shortages will become very real, and they can be expected to lead to a much higher oil price. Oil is not the whole story: there are many other commodities such as fertiliser, which come out of the Gulf. All of these will lead to shortages that will become increasingly apparent the longer the strait remains closed. A crisis in food production is one very real possibility.
In the ugly scenario, I have not mentioned the energy infrastructure. This is partly because the issue of how much of it is destroyed becomes relevant only after the strait is opened. But if hostilities restart, then the possibility of further infrastructure being destroyed becomes possible. Since I am restricting my forecast to the next 12 months, this effect lies outside the period of analysis.
What are the prospects for UK inflation?
I can now put together the three scenarios into predictions for the possible path of inflation until May 2027 (see Figure 1).
Figure 1: Three scenarios for the path of UK inflation, 23 months to May 2027
Source: author's calculations.
The good and bad scenarios share a common path until the end of 2026: inflation peaks at around 4% in November. Thereafter, the paths diverge: in the good scenario, inflation falls and reaches 2.7% by May 2027. Under the bad scenario, it falls less slowly and is still at 3.3% next May.
Under the ugly scenario, inflation increases to 7% and remains high. This scenario is the hardest to model with confidence: the inflation shock here is almost certainly larger than what we saw following Russia’s full-scale invasion of Ukraine, so it is quite possible that inflation will rise to much higher levels.
The reaction of energy prices to the deal has been very positive. The price of oil has fallen rapidly: since the announcement of the deal, prices have fallen from $85 to $75.
We can interpret the current oil price in a simple way as a weighted average of expected oil prices: there is probability p of a high oil price (the ugly case) and probability (1-p) of a low oil price (the good case).
The volatility of the spot price reflects shifts in the probabilities: it goes up when hostilities escalate, raising p; and declines when the prospects of a settlement look better. The fall in prices after the deal indicates that for markets, the probability of the ugly scenario happening has gone down significantly. But the oil price still remains higher than the pre-war level of $60, indicating that p is certainly not zero.
Other potential factors
In these three scenarios, I have not mentioned any domestic factors or additional geopolitical factors. That is because I think that they are simply less important than what happens in the Persian Gulf.
But we know that in general, inflation in the UK tends to be persistent and that various forms of indexation (such as the minimum wage and regulated prices) and the Ofgem price cap can lead to inflation falling slowly.
The issue of Taiwan is unlikely to arise: the United States is in no condition to confront China until it has restored its weapons inventories, which will take several years. And the Ukraine conflict is unlikely to have an inflationary impact unless it turns into direct war between NATO and Russia.
Overall, we must hope that the Iran-US deal succeeds. The huge costs to both sides if it does not suggest that rational players would maintain the ceasefire and arrive at a peaceful settlement. But rationality in international affairs seems to be in short supply at the moment and cannot be counted on to prevent the renewal of conflict in the Persian Gulf.
Where can I find out more?
- For more details on how the forecasts in this article are made, see the monthly inflation blog posts by Huw Dixon on the NIESR website, including the most recent, this mid-June piece: The calm before the inflation hike.
- See also his piece in NIESR Economic Outlook Summer Outlook 2021 – Box A: The simple arithmetic of inflation. Using ‘drop-in’ and ‘drop-out’ for exploring future short-run inflation scenarios).
- Monetary policy report 2026: latest quarterly publication from the Bank of England on the economic analysis and inflation projections that the Monetary Policy Committee uses to make its interest rate decisions.
- Consumer price inflation, UK: May 2026: latest ONS data and commentary.
 Who are experts on this question?
- Jagjit Chadha
- Huw Dixon
- Michael McMahon
- Swati Dhingra
- Silvana Tenreyro
