The Bank of England has been forced to rethink its rate-cutting plans following the outbreak of the US-Israel war against Iran, holding rates at 3.75% on Thursday and warning that borrowing costs could instead need to rise in the months ahead. The monetary policy committee voted unanimously to hold, but the accompanying language was a clear departure from the dovish tone that had characterised recent meetings. Officials described the conflict as a “new shock” to the UK economy with potentially serious implications for inflation.
The war has disrupted global energy markets in a way that threatens to push UK inflation well above the Bank’s 2% target. Before hostilities began, the Bank had expected inflation to reach target around April, with rate cuts to follow. Those projections have now been scrapped, replaced by forecasts showing inflation rising to approximately 3.5% in March and remaining elevated throughout 2026.
Governor Andrew Bailey said the war had thrown a major variable into calculations that had recently appeared relatively clear. He pointed to rising petrol prices as an early indication of the shock and warned that household energy bills could rise significantly if supply routes remain disrupted. Despite these concerns, he urged caution about interpreting the hold as a prelude to automatic rate hikes.
Financial markets took a different view, pricing in a June rate hike and a further increase before December. UK gilt yields moved higher and the FTSE 100 fell, while the pound strengthened against the dollar. Analysts highlighted the growing gap between the Bank’s cautious messaging and market expectations for tightening.
The political implications are significant. Several MPC members had been poised to vote for a cut before the war changed the picture. Even Swati Dhingra, previously among the most consistent advocates for lower rates, indicated openness to rate hikes if inflation persisted. The next few months will determine whether the Bank’s caution was well-founded or whether the energy shock forces its hand.
