Households warned Iran war could drive inflation to 5 per cent and spark fresh cost of living crisis

Britain faces a painful period of stagflation as war in the Middle East threatens to drive inflation to 5 per cent and tip the economy into recession.

After the price of oil soared towards $120 a barrel before easing, ING and RSM UK warned inflation could jump to well over double the Bank of England’s 2 per cent target.

And a separate report from WPI Strategy warned that recession was now a distinct possibility as the escalating conflict batters and already floundering economy.

That raises the punishing prospect of a bout of ‘stagflation’ – when stagnation in the economy combines with rapidly rising prices in a devastating blow to living standards.

Susannah Streeter, chief investment strategist at Wealth Club, said: ‘The worsening situation in the Middle East has the potential to bring a toxic combination of shocks to economies.

‘Inflation is set to rise sharply, given the spike in energy prices, which may lead central banks to keep interest rates higher for longer. Higher energy prices and borrowing costs will be a drag on growth, and the concern is that governments lack the financial firepower, given high debt levels, to deliver meaningful support to companies and consumers.

‘The spectre of stagflation is hovering, with high inflation and stagnant growth looking increasingly likely unless there’s a rapid de-escalation in the Middle East.’

The surge in oil and gas prices leaves households and businesses facing sharply higher prices at the petrol pumps and soaring energy bills.

Before war broke out, inflation had been expected to fall back to 2 per cent in the coming months, paving the way for the Bank of England to cut interest rates yet again.

It was hoped a rate cut could come as soon as next week.

But the prospect of such a move has evaporated.

And it is now feared the Bank may be forced to raise interest rates before the end of the year in a desperate bid to bring inflation back under control.

That would push up the cost of mortgages for millions of households.

Tom Pugh, an economist at RSM UK, said: ‘5 per cent is the upper range of where we think inflation will land if current energy prices are maintained through the next few quarters’.

James Smith at ING put the figure at 4.7 per cent.

And Martin Beck, chief economist at WPI Strategy, said ‘the economy could stagnate or even slip into recession’ this year as households and businesses are hit by rising costs.

Chris Beauchamp, chief market analyst at IG, said policymakers at the Bank of England ‘risk setting off a much deeper recession if they get too trigger-happy on rate hikes’ as they seek to control inflation.

Daniela Hathorn, senior market analyst at Capital.com, said: ‘The oil shock comes at an already fragile moment for global monetary policy.

‘Interest rate markets in Europe and the UK are beginning to price in a reduced probability of further rate cuts — and in some cases even hikes — as higher energy prices threaten to lift inflation.

‘In the US, expectations for rate cuts have also been pushed back. This creates a worst of both worlds scenario: a supply shock that raises inflation while growth momentum appears to be slowing.’