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| The Bank of England, the institution at the center of the UK's inflation battle as the Iran war reshapes the global economic outlook. |
Just weeks ago, the Bank of England appeared to be gliding
toward a textbook soft landing. Inflation was cooling. The labor market was
softening. Policymakers were widely expected to cut interest rates, providing
long-awaited relief to British households and businesses still nursing wounds
from years of elevated borrowing costs. Then, on February 28, 2026, the United
States and Israel launched military strikes on Iran — and everything changed.
From Rate Cuts to Rate Holds: How the Iran War Reshuffled the Deck
Until the war erupted, it was seen as a near certainty that
the Bank of England would cut interest rates, with UK inflation expected to
fall towards the 2% target in the coming months. That consensus has now
evaporated.
In a widely anticipated move, the Bank of England left its
main interest rate on hold at 3.75%. "We have held interest rates at 3.75%
as we assess how events unfold," Bank Governor Andrew Bailey said.
"Whatever happens, our job is to make sure inflation returns to its 2%
target."
The decision was striking not just for what it did, but how
it was made. All nine members of the Monetary Policy Committee voted
unanimously to keep borrowing costs on hold — the first such unanimous decision
in more than four years. In February, the vote had been a knife-edge 5-4. That
shift speaks volumes about how dramatically the economic calculus has shifted
in less than three weeks.
The Strait of Hormuz: A Chokepoint for Global Inflation
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| The Strait of Hormuz, the narrow waterway through which roughly one-fifth of the world's oil and gas supply flows, has become the most consequential chokepoint in global energy markets. |
At the heart of the Bank of England's dilemma is a critical piece of global plumbing — the Strait of Hormuz. Shipping through this narrow waterway, which carries around one-fifth of global oil and liquefied natural gas supply, has almost ground to a halt following Iranian attacks on vessels attempting transit.
For Britain, this is not a distant abstraction. The UK
imports around 40% of its oil supplies and up to 60% of its natural gas, making
it highly sensitive to energy price fluctuations despite its dwindling North
Sea production. When energy arteries are blocked, British consumers feel it
quickly — at the petrol pump, on utility bills, and in the price of goods
across the supply chain.
Brent crude has surged to $111.10, a 3.5% rise, while
natural gas prices have also climbed sharply. These are not minor fluctuations.
They are the kind of sustained price shocks that feed stubbornly into
underlying inflation.
The Second-Round Effect Problem
The Bank of England's monetary framework has always been
designed to "look through" short-term volatility in commodity prices.
The real danger is what happens next: second-round effects.
Monetary policy cannot directly influence global energy
prices, but it aims to ensure that the economic adjustment occurs in a way that
keeps inflation at the 2% target sustainably. If businesses start raising
prices and workers start demanding higher wages in response to the energy
spike, the initial shock gets baked into the economy for years, exactly what
happened after the 2022 Ukraine-Russia energy crisis. Wage settlements in 2026
are already expected to rise to 3.6%, reinforcing concerns that second-round
effects remain a very real threat.
Markets Pricing in Rate Hikes, Not Cuts
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| Brent crude surged past $100 a barrel following Iranian attacks on Gulf energy infrastructure, sending shockwaves through global commodity markets and UK household energy bills. |
Perhaps the most telling signal of how severely the Iran
crisis has disrupted the monetary outlook is what financial markets are now
pricing in. "Things have shifted at such a pace that markets are now
expecting rates to be raised by at least a quarter of a percent this year if
not half of one," said Lindsay James, investment strategist at Quilter.
The unanimous MPC decision has effectively ended hopes of
any further rate cuts in 2026, dramatically reversing a policy outlook that
looked very different just two weeks ago.
The Path Forward: Waiting for the Fog to Clear
For now, the Bank of England finds itself in an
uncomfortable but familiar position: watching, waiting, and hoping that
geopolitical conditions stabilize before making its next move.
"While another interest rate cut remains possible if
the Iran war ends quickly, with skyrocketing oil and gas prices locking in an
imminent inflation spike, the chances of further policy loosening this year is
rapidly receding," said Suren Thiru, chief economist at ICAEW. Some
economists, including Andrew Wishart of Berenberg Bank, suggest a June cut
remains on the table but only if the Strait of Hormuz reopens swiftly.
The Iran crisis has, in the starkest possible way, reminded
investors, businesses, and policymakers alike that no monetary model , however
sophisticated , is immune to the unpredictable force of geopolitics. The Bank
of England did not fail; it adapted. But the real test is still ahead, and the
2% inflation target remains as elusive as peace in the Middle East.
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