A war fought thousands of miles from British shores is spelling trouble at home, as the Bank of England held interest rates at 3.75% on Thursday and warned that the US-Israel conflict against Iran could drive UK inflation above 3% and trigger rate hikes within months. The monetary policy committee voted unanimously to hold, pausing what had been an anticipated easing cycle to assess the scale of the energy price shock. Officials described the conflict as a significant new threat to the UK’s economic stability.
The trouble began with the outbreak of war, which rapidly pushed global oil and gas prices higher and threatened the steady disinflationary progress the UK had been making. Before the conflict, the Bank had expected inflation to approach the 2% target by April and had been edging toward a rate reduction. The war has reversed that outlook, with the Bank now projecting inflation of approximately 3.5% in March and above-target price growth well into 2026.
Governor Andrew Bailey described the challenge directly. He said that reopening the energy supply lines disrupted by the conflict was the most effective solution to the inflation threat, but that this was beyond the Bank’s power to deliver. Within its mandate, the Bank would use interest rate policy to prevent a persistent inflation overshoot, standing ready to act if the situation warranted it.
City markets responded to the Bank’s hawkish tone. UK gilt yields rose, the FTSE 100 fell, and the pound gained against the dollar as traders increased bets on rate hikes in June and later in the year. Analysts highlighted rising mortgage rates as an early sign that the shift in expectations was already feeding through to household finances.
The broader economic picture complicates the Bank’s task. Unemployment has risen to 5.2% and wage growth has slowed, conditions that would normally support monetary easing. But the war has introduced an overriding external factor that policymakers cannot ignore, leaving the Bank in the unenviable position of potentially having to tighten policy into an already softening economy.: