Britain’s central bank has once again left interest rates unchanged at 3.75%, but the Iran war has reshaped the UK policy horizon so dramatically that the hold was almost beside the point. The monetary policy committee voted unanimously to stay put while warning that energy price inflation triggered by the US-Israel conflict could force borrowing cost increases within months. The decision represents a clear and significant departure from the rate-cutting expectations that had dominated monetary policy discussions just weeks earlier.
The war against Iran has had immediate and substantial consequences for global energy markets. Oil and gas prices have surged, threatening to push UK inflation back above 3% and undermining the progress made toward the Bank’s 2% target. The Bank now projects inflation rising to around 3.5% by March and remaining elevated well into 2026, a materially different outlook compared to pre-war forecasts.
Governor Andrew Bailey was forthright about the challenges posed by the conflict. He said the energy price impact was already visible in the real economy, particularly at petrol stations, and warned of the potential for higher household bills if supply disruptions continue. The Bank, he said, would not stand aside if inflation threatened to become entrenched, but for now it was choosing a stance of careful observation.
The market response was swift and clear. UK gilt yields rose, the FTSE 100 declined, and the pound strengthened against the dollar. Financial markets are now pricing in a June rate hike with high probability and a second increase before December. Analysts noted that five-year fixed mortgage rates had already moved to their highest levels since early 2025.
Labour’s economic agenda faces an uncomfortable challenge from the changing rate environment. Its growth strategy had relied on lower borrowing costs, and rising rates directly undermine that calculation. Opposition politicians have been quick to exploit the political opportunity, while the chancellor reportedly weighs the options for providing energy cost relief to struggling households.