The Bank of England held interest rates at 3.75% on Thursday in a unanimous decision, but the message from policymakers was clear: the war in the Middle East has changed the economic picture significantly, and higher borrowing costs may lie ahead. Officials warned that energy prices driven up by the Iran conflict could push UK inflation above 3% and undermine the progress made in recent months. The decision marks a decisive pause in what had been an anticipated path toward lower rates.
The UK economy had been showing signs of modest improvement, with inflation trending lower and wage pressures beginning to ease. However, the US-Israel military campaign against Iran has disrupted global energy markets in ways that threaten to reignite inflationary pressure. The Bank said it viewed this as a “new shock” with potentially significant consequences for the near-term inflation outlook.
Governor Andrew Bailey said the effects were already being felt at petrol stations and warned of higher household energy bills if supply disruptions persist through the year. He emphasised that the Bank’s goal remained returning inflation to its 2% target, whatever the circumstances. To achieve that, the Bank said it stood ready to act if necessary.
Financial markets interpreted the Bank’s statement as a hawkish signal, with traders increasing their bets on rate hikes in June and later in the year. UK government bond yields rose, the pound strengthened against the dollar, and the FTSE 100 declined. Analysts said five-year fixed mortgage rates were already reaching levels not seen since early 2025.
Some MPC members had favoured a cut prior to the outbreak of the war, but the conflict appears to have shifted internal opinion on the committee. Even traditionally dovish members indicated some openness to rate increases if inflation proves persistent. For the UK’s already stretched households, the outlook for borrowing costs has deteriorated sharply in a matter of weeks.