Small and medium-sized businesses across the United Kingdom are preparing for a sharp economic slowdown as rising energy costs, geopolitical instability, and weakening consumer demand converge to threaten growth prospects in the months ahead.
The Item Club has warned that the UK economy is set to “flirt” with recession through the second and third quarters of the year, with growth expected to slow to 0.7 percent in 2026, down from 1.4 percent last year. The outlook for 2027 is only slightly improved, with growth forecast at 0.9 percent, still below historical averages.
The downturn is being driven in part by turmoil in global energy markets following disruption in the Strait of Hormuz, through which roughly one-fifth of global oil supplies pass. The International Energy Agency has described the situation as the most significant oil supply shock in history.
Shipping through the waterway has remained severely restricted after renewed tensions between Iran and the United States. Markets briefly reacted positively when signals emerged that the Strait might reopen, but uncertainty quickly returned after conflicting statements from both sides. Brent crude prices remain volatile, fluctuating after sharp swings in recent weeks.
Economists warn that higher energy prices will filter through to households and businesses, squeezing spending power and increasing operating costs. Matt Swannell, chief economic adviser at the Item Club, said tighter financial conditions and geopolitical uncertainty are already weighing on investment decisions, particularly among smaller firms.
The labour market is also expected to weaken. The Item Club forecasts unemployment rising to 5.8 percent by mid-next year, with around 250,000 additional job losses. Analysts say the shift is increasingly being driven by redundancies rather than new entrants struggling to find work, a trend that typically places greater strain on smaller employers.
Inflation is expected to remain above the Bank of England’s 2 percent target through the end of the year, although economists do not expect a repeat of the sharp price spikes seen in 2022. Weak demand is likely to limit how much firms can pass on higher costs to consumers.
Corporate data also points to growing pressure. Analysis from EY shows that nearly half of UK profit warnings in the first quarter cited geopolitical instability and policy uncertainty. Sectors reliant on consumer spending, particularly travel and leisure, have been among the hardest hit.
At the same time, consumer confidence has fallen to its lowest level since 2023, according to Deloitte, with households reporting reduced disposable income and weaker intentions to spend on non-essential goods and services.
For SMEs, the combination of rising costs, soft demand, and economic uncertainty is expected to test resilience. Analysts say businesses that focus on strengthening cash flow and managing exposure to volatile energy and supply chain conditions will be best positioned to navigate the downturn.
