Bank of England holds rates, and warns of ‘new shock to economy’ from Middle East crisis
Newsflash: The Bank of England has kept UK interest rates on hold at 3.75%, as it weighs up the impact of the Middle East conflict on Britain’s economy.
As expected, the Bank’s rate-setting monetary policy committee (MPC) voted by a majority to keep its key base rate at the current level of 3.75% (before the Iran war, a rate cut today had been widely predicted)
The decision is unanimous too; all nine policymakers on the Monetary Policy Committee agreed that rates should remain on hold.
The Bank is also warning that inflation will be higher in the “near term” due to the shock from higher energy prices.
It says:
Conflict in the Middle East has caused a significant increase in global energy and other commodity prices, which will affect households’ fuel and utility prices and have indirect effects via businesses’ costs. Prior to this, there had been continued disinflation in domestic prices and wages. CPI inflation will be higher in the near term as a result of the new shock to the economy.
Key events
Why the Bank of England is really worried
The Bank of England’s MPC is “really worried” about the inflationary impact of the oil shock, Professor Costas Milas of the Management School at University of Liverpool tells me.
Professor Milas explains:
To see this, I plot the impact of the oil shock (assuming oil prices stay at their current level for a while rather than dropping fast or even…rising further).
UK inflation rises by up to 1.5 percentage points by the end of the year and reaches a peak in early 2027. The impact is statistically significant (using a 95% confidence interval) in a model of oil prices, inflation, UK growth and Bank Rate. This is clearly a nasty oil price shock…
ECB leaves eurozone interest rates on hold and hikes inflation forecasts
The European Central Bank has voted to leave eurozone interest rates unchanged.
Announcing its decision, the ECB says it is “determined to ensure that inflation stabilises at the 2% target in the medium term”.
The eurozone central bank warns:
The war in the Middle East has made the outlook significantly more uncertain, creating upside risks for inflation and downside risks for economic growth.
It will have a material impact on near-term inflation through higher energy prices. Its medium-term implications will depend both on the intensity and duration of the conflict and on how energy prices affect consumer prices and the economy.
It has also lifted its inflation forecasts, due to the Middle East war. Headline inflation is now expected to average 2.6% in 2026, 2.0% in 2027 and 2.1% in 2028.
Back in December, the ECB had forecast inflation would be 2.2% in 2026, 1.9% in 2027 and 2.0% in 2028.
FTSE 100 share index dips below 10,000 points
The stock market selloff is accelerating in London.
Almost 3% has been wiped off the blue-chip FTSE 100 share index so far today. It just fell below the 10,000 point mark, hitting 9997.41 points, its lowest since 8 January, before struggling back to 10,004 points…
Apart from BP (+2.5%), every share on the index is down today.
Precious metal producers Fresnillo (-9.2%) and Endeavour Mining (-9%) are leading the sell-off, with banks, and mining companies also among the top fallers.
Before the Iranian war began, the FTSE 100 hit 10,934 points – so it’s lost 8.5% of its value since, hitting the value of pension funds and ISAs across the UK.
The market panic caused by the Middle East crisis is continuing to ripple across assets today.
Silver has tumbled by almost 11% to $67.1 an ounce.
Gold is down 5.7% at $4,539 an ounce.
Two-year bond yields on track for biggest jump since 2022 mini-budget crisis
UK government bond prices are being hammered by City traders, following the Bank’s warning that the energy crisis could create ‘second round’ effects to push inflation higher.
With prices falling, the yields (or interest rate) on UK gilts are pushing sharply higher.
Shorter-dated UK bonds are particularly hit.
The yield in two-year gilts have jumped by 35 basis points (0.35 of a percentage point) to 4.47%, the highest since January 2025.
That puts them on track for the biggest daily increase since Liz Truss’s “mini-budget” crisis of September 2022.
The Bank of England MPC must have had one of their most difficult meetings, before deciding to leave rates unchanged today, suggests Michael Browne, global investment strategist at Franklin Templeton Institute.
He writes:
What should they do in the face of a very real inflationary threat? As we dust off the 2022 playbook, we know the damage energy driven inflation can inflict – but to use the Scottish legal term, it is not yet proven.
“Last night, US markets sold off sharply after [Federal Reserve] chairman Powell failed to sound tough enough. Bond markets are nervous and need reassurance that monetary authorities are on top of their brief and prepared to raise interest rates sooner rather than later.
The minutes suggest the MPC is very alive to the risks and while that may not be enough for the market today, investors should be re-assured that they will act, even though a rate rise would be bad news for the economy.”
In the parallel universe where the US and Israel didn’t attack Iran on 28 February, we’d probably be talking about a cut to interest rates today.
Just before the war, a rate cut today was seen as an 80% chance by the money markets.
Bank deputy governor Sarah Breeden says she would have expected to vote for a cut today, has circumstances not changed:
Conflict in the Middle East has significantly shifted the outlook for inflation. Absent this shock, the underlying disinflation process had continued broadly as I expected and, consistent with my vote in February, I would have expected to vote for a cut again in March. But the conflict will have a significant, though at this point highly uncertain, impact on inflation.
Why are mortgage rates going up when the Bank of England base rate hasn’t changed?
Although the Bank of England has left rates on hold today, mortgage rates have been rising since the Iranian war began.
Here’s why:
Bank now expected to raise interest rates twice this year
City traders are betting that the Bank of England will raise UK interest rates at least twice this year, to combat the inflationary hit from the Middle East crisis.
The money markets are now fully pricing in a quarter-point rise in Bank rate, to 4%, by June.
A second hike, to 4.35%, is fully priced in by September.
These implied interest rates are volatile today, though.
Traders are reacting to the Bank’s prediction that inflation will average 3% in the second quarter of this year, not fall to 2.1% as previously expected (see here).
They are also noting its concern about the risks of “second-round effects in wage and price-setting” – that high energy bills will lead to higher wage demands, and higher prices in the shops.
