Middle East conflict: what widening hostilities could mean for the economy and construction

BCIS senior economist Sam Parkin considers the latest escalation in the Middle East conflict and what renewed pressure on energy prices could mean for the UK economy and construction industry.

Developments in the Middle East conflict in early September have pushed oil and gas prices higher, increasing the risk of further pressure on construction input costs, while adding to uncertainty around demand and viability.

For now, the effect is likely to be concentrated in fuel and energy-intensive resources rather than leading to a broad-based acceleration in materials inflation. The extent of any wider impact will depend on how long disruption lasts and how extensively it affects energy markets, supply chains and financing conditions.

Events in recent days have highlighted the fragility of the situation. Brent crude, the international benchmark for oil prices, moved above $100 per barrel on 9 September, exceeding the level reached in July. This followed attacks by Yemen’s Iran-backed Houthi movement on Saudi Arabian energy facilities, which disrupted some operations, as well as escalating tensions in the Gulf of Oman and near Kharg island, where US forces have struck Iranian oil tankers. Tehran has responded with missile attacks on a US base in Jordan and says it has also targeted two US vessels and eight oil tankers in the Strait of Hormuz.

Iranian authorities are also reportedly planning a new restricted zone around the Strait of Hormuz following an escalation in shipping attacks involving the US and Iran. The boundaries of the zone have yet to be confirmed, as have details of reported sanctions on vessels passing through it.

Further constraints on shipping could add friction to supply routes and maintain upward pressure on oil prices. Iran has said it will only fully reopen the waterway once US hostilities have ceased.

Gas markets are also under renewed pressure. UK natural gas prices breached 197 GBp/therm on 9 September, the highest level since the end of 2022. Europe is approaching winter with unusually low inventories, which has contributed to continental prices reaching a three-year high.

High wholesale prices have discouraged companies from replenishing inventories, while disruption to global gas supplies has increased competition for available supply.

Shortages are not inevitable, but lower inventories leave Europe more exposed to further disruption, particularly in the event of a colder winter or another supply shock. A harsh winter, which may be on the cards depending on the impact of the El Niño developing in the Pacific, will only increase demand for natural gas and elevate inflationary pressure, hence the increase to the energy price cap in October.

EU member states and the European Commission have said there is no immediate threat to security of supply, but they continue to monitor the situation closely⁽¹⁾. For the UK, the concern is its exposure to this volatility as one of Europe’s largest gas consumers and a country with relatively limited domestic storage capacity.

What could this mean for the wider economy?

Further pressure on energy prices adds uncertainty to the UK economic outlook.

Higher oil and gas prices can increase production and operating costs for businesses. If sustained, they could also influence broader price- and wage-setting behaviour, second-round effects that could contribute to more persistent inflationary pressure.

This remains an important consideration for the Bank of England (BoE) and its approach to monetary policy in the coming months. As BoE Governor Andrew Bailey told MPs on 8 September, risks to inflation remain on the upside and much will depend on how the situation in the Middle East develops.

Energy prices could rise further or remain volatile if the conflict escalates, particularly if attacks continue to affect energy infrastructure and alternative supply routes used to mitigate disruption through the Strait of Hormuz.

Releases from strategic oil reserves have helped to ease some of the immediate pressure on markets, but their effect is likely to be temporary. The longer that disruption persists, the greater the risk that higher energy prices feed through into UK inflation and complicate the outlook for monetary policy.

Bank Rate is inherently difficult to predict, with decisions dependent on how economic conditions develop. However, the combination of the developing situation in the Middle East, associated inflation risks and higher borrowing costs makes a near-term cut in Bank Rate appear less likely. The UK government recently paid its highest interest rate on a 30-year bond since 1998⁽²⁾.

What could this mean for construction?

For now, the overall picture for construction remains relatively unchanged.

The latest S&P Global UK Construction PMI showed further contraction in activity in August with the headline index falling to 44.3 from 44.7 in July. Housing recorded the sharpest downturn at 37.6, while commercial and civil engineering activity also remained in contraction.

At the same time, input cost inflation eased to a six-month low, despite firms reporting higher fuel and raw materials costs. However, this coincided with easing energy costs and so will likely increase in September’s reading.

This illustrates the tension facing the industry. Transport and some resource costs may come under renewed pressure, but subdued demand and competition for work are limiting the extent to which businesses can pass higher costs on to clients.

This is broadly consistent with trends BCIS has observed, with tender prices rising more slowly than underlying costs. If sustained, this could put further pressure on contractor and supplier margins and potentially keep industry insolvencies at a higher level, relative to pre-pandemic trends.

As ever, the effects of the latest escalation on construction will depend largely on its duration and severity. Further disruption to the Strait of Hormuz, attacks on energy infrastructure elsewhere in the region, or greater involvement by parties aligned with either the US or Iran could keep energy costs elevated for longer.

The impact of this is likely to be twofold.

First, higher oil and gas prices could continue to push up the cost of fuel and energy-intensive resources. Additional inflationary pressure could also trickle through the supply chain to more downstream products, though exposure will vary considerably between materials, products and individual supply chains.

Second, there could be continued implications for demand and financing. For example, if higher energy prices contribute to more persistent inflation expectations, higher market interest rates, mortgage rates and tighter financial conditions could continue to impact demand conditions, development finance and investment decisions.

This is particularly relevant to housebuilding where affordability and viability remain constrained. Governor Bailey noted that UK mortgage rates have risen more sharply than in most other G7 countries since the conflict began.

The conflict’s impact is also likely to vary by market segment. According to the latest BCIS industry panel insights, commercial fit-out and refurbishment continue to provide opportunities, while speculative work in both residential and commercial markets appears less stable.

With the outlook for the Middle East conflict highly uncertain, the focus for those involved in cost planning should remain on the level of exposure of individual projects. Short-term movements in oil and gas prices should not be assumed to translate uniformly into construction inflation.

This reinforces the importance of analysing costs at project level, rather than benchmarking against headline inflation. Construction-specific indices and project-level evidence can provide a stronger basis for early cost planning and budgeting, helping to ground assumptions at a time when heightened uncertainty may otherwise lead to overly broad contingency allowances.

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^{(1) European Commission – Gas Coordination Group: No immediate security of supply risk - here}

^{(2) The Guardian – UK government pays highest interest rate on 30-year bond since 1998 – here}