Bank of England Holds Rates as Energy Prices Drive Inflation

The Bank of England kept its benchmark interest rate unchanged at 3.75% in a unanimous decision, as policymakers weighed rising inflation risks driven by escalating tensions in the Middle East against a persistently weak domestic economy.

The Monetary Policy Committee (MPC) said surging global energy and commodity prices — triggered by the widening U.S.-Israel-Iran conflict — have significantly increased near-term inflation pressures. While holding rates steady, the central bank stressed it remains highly vigilant to second-round inflation effects and stands ready to act to ensure inflation returns to its 2% target over the medium term.

Middle East Conflict Drives Energy Price Surge

The Bank of England identified geopolitical tensions in the Middle East as the dominant source of current economic disruption. The conflict has spread across the wider region, with targeted attacks on energy infrastructure severely disrupting global supply chains.

Shipping through the Strait of Hormuz — a critical route for roughly one-fifth of global oil and liquefied natural gas flows — has nearly come to a halt, pushing energy prices sharply higher.

Brent crude oil prices have risen above $100 per barrel, up about 60% from levels referenced in the Bank's February report and marking their highest point since 2022. European wholesale gas prices, measured by the Dutch TTF benchmark, have climbed above €50 per megawatt hour, also up around 60% from pre-conflict levels. U.K. natural gas futures have increased by 35% to 40%, a move expected to raise the domestic energy price cap between July and September.

Coordinated releases of strategic petroleum reserves by members of the International Energy Agency have only partially offset supply disruptions, with logistical constraints delaying their full impact.

Beyond energy, prices of key commodities such as fertilizers and neon gas have also increased. At the same time, global financial conditions have tightened: equity markets in advanced economies have declined, corporate bond spreads have widened, and the U.S. dollar has strengthened modestly against sterling.

Inflation Outlook Deteriorates as Energy Costs Rise

Prior to the escalation in conflict, U.K. inflation had been moderating. Consumer price inflation fell to 3.0% in January from 3.4% in December, while private-sector wage growth came in below earlier expectations.

However, the surge in energy prices has materially worsened the short-term inflation outlook.

The Bank now expects inflation to approach 3.5% in March — around 0.5 percentage points higher than projected in February. Inflation is forecast to remain near 3% in the second quarter of 2026, significantly above the previous estimate of 2.1%.

If current wholesale gas prices persist, an increase in the energy price cap from July could add approximately 0.75 percentage points to inflation in the third quarter. Combined with indirect cost pass-through by businesses, inflation could rise to around 3.5% during that period.

Market-based measures of inflation compensation have also increased notably since the conflict began, particularly at shorter horizons, raising concerns that inflation expectations could become less anchored.

Weak Economic Growth and Soft Labor Market Persist

Despite rising inflation, the underlying U.K. economy remains subdued.

Gross domestic product grew by just 0.1% in the fourth quarter of 2025, slightly below earlier expectations. Economic activity has remained weak into early 2026, with January GDP flat and first-quarter growth projected at only 0.1% to 0.2%.

The labor market has also softened. The unemployment rate stood at 5.2% in the three months to January, while the ratio of vacancies to unemployment remains below equilibrium levels, indicating weak labor demand.

Monetary conditions have continued to tighten. Overnight index swap rates have risen back to early-2025 levels, and some lenders have increased mortgage rates. While broad money growth (M4ex) remains at 3.6% year-on-year, its pace slowed in January.

Policy Trade-Off: Inflation Risks Versus Growth Pressures

The Bank emphasized that monetary policy cannot directly influence global energy prices. Instead, its objective is to ensure that the economy adjusts in a way that allows inflation to return sustainably to the 2% target.

Policymakers highlighted the risk that prolonged energy price increases could trigger second-round effects through wage and price-setting behavior. The Bank has revised its forecast for private-sector pay growth in 2026 up to 3.6%, reflecting increased risks of persistent inflation.

At the same time, officials noted that the current economic backdrop differs from the 2022 energy shock. With growth already below potential and spare capacity present, higher energy costs may suppress demand by reducing real household incomes and weakening business and consumer confidence.

This could dampen consumption and investment, potentially limiting the scale of inflationary spillovers.

Policy Stance: Hold for Now, Ready to Respond

The MPC said it remains difficult to assess the duration and magnitude of the geopolitical shock, and that developments over the coming weeks will be critical in determining its economic impact.

The central bank outlined a conditional policy approach. A more persistent and severe shock — particularly one that generates clear second-round inflation effects — could require a more restrictive monetary stance. Conversely, a short-lived disruption or a significant widening of economic slack could justify policy easing.

Several committee members indicated that, in the absence of the conflict, they would have supported a rate cut at this meeting. Others warned that rising inflation persistence risks may require maintaining current rates for longer, or even considering further increases.

For now, the Bank of England has opted to hold rates steady, balancing elevated inflation risks against a fragile economic outlook amid heightened global uncertainty.