Danni Hewson, head of financial analysis at AJ Bell, comments: “Although rate setters held the Bank of England’s base rate at 3.75% in February, the minutes stated that it was ‘likely to be reduced further’. This now feels like a distant memory.
“At the start of the year markets had priced in two cuts for 2026. Inflation was cooling and on track to hit the Bank’s 2% target by early spring, and the economy was, in its words, ‘subdued’. Then came December’s jobs data which showed unemployment had shot up to a five-year high at the end of 2025 and looked set to rise further as the impact of the chancellor’s first Budget hit home.
“The potential that the Bank may have to inject a bit of oomph into the UK economy led to increased speculation that two rate cuts might not be enough stimulus, and that base rate could fall as low as 3% by the end of the year.
“But the escalating conflict in the Middle East has sent shockwaves through the global economy and that’s going leave MPC members stuck between a rock and a hard place. Energy prices have shot up, with the price of oil particularly volatile as shipping chains are disrupted and some production is suspended as Iran seeks to use energy as a weapon in the conflict – indeed, it has warned the world should be ready for prices to surge over $200 a barrel.
“Markets are already pricing in the unwelcome return of uncomfortable levels of inflation, with bond yields rising significantly and investors eyeing the UK as particularly sensitive to an energy shock. Preventing inflation from spiralling once again will be at the forefront of rate setters’ minds when they sit down to re-write the Bank’s playbook next week.
“But they face a difficult balancing act of curbing price hikes without completely stalling the country’s economic engine, which is already spluttering. Whilst the return of double-digit inflation seems unlikely, anyone trying to plot its course might wish for another pot of tea to stir, because right now the leaves are impossible to read. The key consideration will be the duration of the conflict, and whether it ends decisively or if attacks on shipping and energy infrastructure continue beyond any declaration of victory by the US president.
“Airfares are already soaring, the price at the pump will make motorists wince, and a much-desired drop in the energy price cap in the summer is most certainly off the table. During the last cost of living crisis businesses gave staff inflation-busting pay increases that helped households cope but also meant the inflationary spike became far stickier than the Bank of England might have hoped for. This time the labour market is slack, companies have already had to deal with increased labour costs thanks to changes to NI contributions, and many will feel unable to dig any deeper when it comes to pay.
“Hiking rates at a time growth has gone AWOL and unemployment is already high raises the ominous spectre of ‘stagflation’, and that’s something no-one wants to see take hold. Faced with an overwhelming number of unpredictable variables, nobody expects the Bank to do anything other than wait and see. But this decision will still be a difficult one, and close attention will be paid to any guidance about the path ahead.”
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