Bank of England and other central banks hit pause on rates as Iran war scrambles projections

The Bank of England maintained its key interest rate at 3.75% on Thursday, signaling potential future hikes as policymakers navigate economic uncertainties stemming from the Iran war and the closure of the strategically vital Strait of Hormuz.

The decision comes amid a week of similar holds by major central banks worldwide, including the U.S. Federal Reserve, Bank of Japan, and European Central Bank, as global financial authorities assess the conflict’s impact on inflation and economic growth.

Minutes from the meeting revealed that eight of the nine rate-setters voted to maintain current rates, with one member advocating for a quarter-point increase. The outcome clearly indicates that further rate increases remain on the table.

“We think this is a reasonable place given the situation of the economy and the unpredictability of events in the Middle East,” Bank Governor Andrew Bailey explained. “Whatever happens, our job is to make sure that inflation gets back to the 2% target after the initial impact of the war on energy prices has passed.”

In an unprecedented move reflecting heightened uncertainty, the Bank published multiple forecast scenarios. Under the most severe projections, UK inflation could surge to 6.2% by early 2027, up from the current 3.3%, if oil and gas prices remain elevated for an extended period. This worst-case scenario would likely necessitate multiple rate increases and significantly raise recession risks.

The outlook marks a stark reversal from pre-war expectations. Before hostilities began on February 28, financial markets had anticipated rate cuts as inflation was forecast to approach the Bank’s 2% target this spring. The conflict has thoroughly disrupted these predictions and broader global economic forecasts.

Energy markets have responded dramatically to the crisis. Brent crude, the international benchmark, briefly surpassed $126 per barrel on Thursday—its highest level since Russia’s full-scale invasion of Ukraine four years ago. Traders are increasingly pricing in expectations that the Strait of Hormuz, through which approximately one-fifth of the world’s crude oil passes, will remain closed for an extended period.

The Bank of England’s Monetary Policy Committee now faces a complex balancing act. Policymakers must monitor whether the inflation spike begins permeating throughout the economy through mechanisms like wage increases. Simultaneously, they must assess how the oil price shock affects overall economic growth and whether it might trigger a recession, which would naturally suppress price increases.

Luke Bartholomew, deputy chief economist at asset management firm Aberdeen, believes recessionary pressures will likely limit secondary inflation effects. However, he cautioned, “if oil prices continue to move higher, it is hard to see how the Bank avoids having to hike later this year.”

The central bank’s decisions will also be influenced by any forthcoming measures from Britain’s Labour government aimed at mitigating inflation’s impact on households and businesses. Treasury Chief Rachel Reeves, whose plans to address cost-of-living concerns have been disrupted by the Middle East crisis, has indicated readiness to provide support when necessary.

“The war in the Middle East is not our war, but it is one we have to respond to,” Reeves stated.

The Bank of England’s cautious approach reflects the profound global economic uncertainty triggered by the conflict. With the Strait of Hormuz’s closure threatening one of the world’s most crucial energy corridors, central bankers worldwide are preparing for potentially prolonged market volatility and inflationary pressures.

For the UK economy, which had been showing signs of recovery after a period of high inflation, the timing is particularly challenging. Businesses and consumers now face renewed uncertainty about energy costs, interest rates, and overall economic stability as policymakers navigate this complex geopolitical landscape.