The Bank of England held interest rates at 3.75% on Thursday, but the decision was accompanied by a clear warning that the war in the Middle East has put inflation firmly back on the danger list for the UK economy. The monetary policy committee voted unanimously to hold while signalling that a June rate hike was increasingly plausible if energy prices continue to rise. The announcement came alongside official data showing unemployment at 5.2%, its highest level in five years.
The outbreak of the US-Israel conflict against Iran has sent global energy prices sharply higher, with direct consequences for UK inflation. The Bank had been projecting a return to its 2% target around April, but now expects inflation to climb to around 3.5% in March and remain above target well into next year. These revised projections represent a significant and rapid change in the outlook.
Governor Andrew Bailey described the conflict as a major new economic shock and said the Bank was monitoring its development closely. He pointed to rising petrol prices as the most immediate evidence of the war’s economic reach and warned that the impact could spread to household energy bills if supply routes remain disrupted. His message was one of preparedness to act, balanced against a desire not to unnecessarily alarm either markets or the public.
Financial markets showed little uncertainty in their interpretation of the Bank’s statement. Traders pushed UK gilt yields higher, sold UK equities, and moved the pound upward against the dollar as they adjusted to a more hawkish outlook. City analysts began revising their forecasts, with many now expecting at least one rate hike before the end of the year.
The political consequences of the changing rate environment are significant. Labour’s economic credibility has been partly tied to the narrative of falling borrowing costs, and rising rates represent an uncomfortable counter-narrative. The government faces fresh pressure to provide targeted financial support to households as the combination of higher mortgage costs and potentially steeper energy bills creates a new financial squeeze.
