Plans for UK interest rate cuts have been derailed by the outbreak of the Iran war, with the Bank of England voting unanimously to hold at 3.75% on Thursday and signalling that borrowing costs could rise rather than fall in the months ahead. The monetary policy committee described the US-Israel conflict against Iran as a new economic shock that had materially changed the UK’s near-term inflation outlook. Officials warned that energy prices driven up by the war could push UK inflation above 3% and force a policy response.
The rate-cutting plan that had been taking shape before the war erupted was grounded in sound economic fundamentals. Inflation was falling toward the 2% target, wage growth was easing, and the labour market was softening. These conditions supported the case for gradual monetary easing. The Iran conflict has overridden that case by introducing a powerful external shock through global energy markets that the Bank cannot ignore.
Governor Andrew Bailey said the Bank had moved to a watching brief in light of the changed circumstances. He pointed to rising petrol prices as an early and tangible sign of the war’s economic impact on UK consumers and warned that household energy costs could follow. The Bank’s response was to hold and monitor, preserving its options rather than committing to a path.
Markets moved to price in a significantly more hawkish outlook. UK gilt yields rose, the FTSE 100 fell, and the pound gained against the dollar as investors recalibrated their expectations. A June rate hike is now widely anticipated among City analysts, with some forecasters predicting a further move before year end. Five-year fixed mortgage rates have already moved higher in response.
The political fallout is building. Labour’s economic agenda had been designed for an environment of declining borrowing costs, and the prospect of rate hikes represents a direct challenge to that framework. The chancellor faces increasing pressure to explain how the government will support households through what may be a difficult and unexpected financial squeeze.
