The Bank of England faces mounting pressure to reassess its monetary policy as inflation risks rise from the conflict in Iran, with officials warning that rates may need to increase rather than fall this year.
Before the US-Israeli strikes on Iran six weeks ago, the Bank was widely expected to cut interest rates to support growth, but rising energy and food costs have shifted the outlook. Governor Andrew Bailey told the BBC the Bank is weighing the IMF’s “serious advice” and waiting for meaningful data on how the conflict is affecting the UK economy, noting that the UK’s strong dependence on gas makes it particularly vulnerable to supply disruptions. He emphasized that the duration of the conflict, not just its outbreak, will determine the economic impact.
Former Monetary Policy Committee member Michael Saunders, now a senior adviser at Oxford Economics, warned that inflation could climb to 4.5% this year from the current 3%, driven by surging fuel and food prices. He argued that pre-emptive rate hikes would be less costly than delaying action and facing sharper increases later if second-round inflation effects take hold. Saunders noted that the average two-year fixed mortgage rate has already risen from around 4% to 5.88% since the conflict began, with five-year fixes at 5.77%, removing cheaper options from the market.
Although the Bank held rates at 3.75% at its last meeting and is expected to maintain a “wait and see” stance at its upcoming 30 April meeting, analysts are split. Paul Dales of Capital Economics said the Bank might tolerate inflation up to 4% given the weak economy, but would likely only act if prices rise significantly above that level. He suggested the Bank may talk tough without delivering a hike unless inflation accelerates further.
For more on this story, see Canadian Finance Minister Warns Global Energy Markets Remain Vulnerable Long After Iran Conflict Ends.
The Bank’s dilemma is compounded by conflicting pressures: inflationary pressures from energy prices versus weakening demand and a softening labour market, which Bailey noted had shown signs of easing before the conflict. This makes it harder to determine whether price rises will become persistent or fade as supply chains adjust. Bailey acknowledged the system has some resilience but warned it could be exhausted if the conflict drags on, stressing that a swift resolution in Gulf energy supplies would ease the burden.
Despite the uncertainty, Bailey offered one point of reassurance, stating he has no concerns about the stability of the banking system, countering arguments that it is over-regulated. He said resilience means “success is when nothing happens,” and that the best path forward for households is credible, consistent policy over time — combining sound central bank action with prudent fiscal decisions on taxation and spending.
Will the Bank of England raise interest rates before the finish of 2024?
It is possible, but not certain. The Bank may act if inflation shows signs of rising significantly above 4%, particularly if second-round effects emerge, but many analysts expect it to hold rates steady unless clearer pressure builds.
How has the conflict in Iran affected mortgage costs in the UK?
The average two-year fixed mortgage rate has increased from around 4% to 5.88%, and five-year fixes to 5.77%, since the conflict began, with lenders withdrawing cheaper deals from the market.
What is the Bank of England waiting for before making a decision on rates?
The Bank is waiting for meaningful data on how the conflict in Iran is affecting the UK economy, especially regarding energy prices, inflation trends, and whether price pressures are likely to persist or fade.
