Bank of England Warns Iran War Energy Crisis Could Force Rate Hikes as Inflation Hits 3.3%

Key facts

• Bank of England held key interest rate at 3.75% on Thursday in an 8-1 vote.
• BOE Chief Economist Huw Pill dissented, voting for a 25 basis-point increase.
• UK CPI rose to 3.3% in March, up from 3% the previous month, driven by fuel prices.
• Governor Andrew Bailey told CNBC that a protracted energy price crunch could force the BOE to act.
• The BOE warned inflation is 'likely to be higher later this year' due to energy price pass-through.
• Over 7 million homeowners (87% of mortgages) have fixed-rate deals; average monthly payments could rise by £80 over three years.
• In the most adverse scenario, oil above $120/barrel could trigger up to six rate hikes, taking the base rate to 5.5%.

Central Bank Holds Fire but Signals Future Hikes

The Bank of England left its benchmark interest rate unchanged at 3.75% on Thursday, but its governor warned that the war in the Middle East is driving inflation higher and could force the central bank to raise borrowing costs later this year. The nine-member Monetary Policy Committee voted 8-1 to hold, with only Chief Economist Huw Pill breaking ranks to call for a quarter-point increase. Governor Andrew Bailey told CNBC that policymakers face the 'most difficult combination' of economic effects: an energy price shock that simultaneously pushes up inflation and depresses economic activity. 'This is what we'd call a negative supply shock,' Bailey said. 'Unfortunately, the increase in price of energy product is also having a negative effect on activity in economy. That's a difficult combination.' Bailey struck a hawkish tone, warning that if higher energy prices become embedded and persistent, 'we will have to respond, because that's our job and that's how we get inflation back to target.' The bank's 2% inflation target remains 'critically important,' he added.

March Inflation Data Shows Price Pressures Intensifying

March's inflation print showed the consumer price index rising to 3.3%, up from 3% in February, as fuel prices pushed the overall basket higher. The BOE said Thursday that inflation is 'likely to be higher later this year as the effects of higher energy prices pass through,' and that it is wary of second-round effects — such as workers demanding higher wages to offset living costs, which could fuel further inflation. Bailey described the outlook for energy prices as 'very uncertain,' but cautioned that a 'long-lived effect' of the current shock would likely see price growth feed into the rest of the economy and embed inflation more deeply. The bank is monitoring how energy prices are feeding through into the economy, the labor market, and employment data.

Rate Cut Expectations Reversed as War Alters Outlook

Prior to the outbreak of the Iran war, most economists expected the Bank of England to cut interest rates in 2026. Those predictions have now reversed, with markets anticipating that the BOE could hike rates later this year. The central bank considered a range of scenarios to determine its response, given the 'uncertainty around the severity and duration' of the conflict. In the scenario Governor Bailey placed most weight on — with energy prices slowly falling — the committee's deliberations suggest one or two rate rises could be on the cards. In the most adverse scenario, where oil prices remain above $120 a barrel for the rest of the year and inflation tops 6% early next year, as many as six rate hikes could be required, potentially taking the base rate to 5.5%.

Millions of Homeowners Face Higher Mortgage Costs

More than seven million homeowners — 87% of all mortgages — have fixed-rate deals, meaning their interest rate does not change until the deal expires, typically after two or five years. When those deals end and homeowners move onto a new rate, the Bank's rate-setting committee estimates that average monthly payments will rise by approximately £80 over the next three years. The bank stresses that this is an average and there could be considerable variation, depending partly on the outlook for energy prices, which have a wide economic impact. Any rise in the base rate would increase the cost of borrowing for new mortgages and variable-rate loans, while also boosting returns on savings.

Bailey Warns of 'Negative Supply Shock' and Uncertain Path Ahead

Bailey told CNBC's Ritika Gupta that the central bank must contend with the consequences of an energy price shock that is both inflationary and recessionary. 'This is what we'd call a negative supply shock,' he repeated, emphasizing the difficulty of the situation. The governor said the decision to hold rates at 3.75% for now is a 'reasonable place given the situation of the economy and the unpredictability of events in the Middle East.' warned that 'higher inflation is unavoidable' after leaving interest rates on hold, and that the bank will be watching closely for signs that the price shock is becoming embedded. Bailey reiterated that reaching the 2% inflation target is 'critically important,' and that the bank will take action if necessary.

Open Questions on the Scale and Duration of the Conflict

The central bank's response hinges on how long the Iran war and its energy price effects persist. In its report, the BOE considered a range of scenarios, from a relatively mild impact to a severe and prolonged crisis. The most adverse scenario — oil above $120 a barrel through the end of the year and inflation exceeding 6% in early 2026 — would require aggressive monetary tightening. Bailey acknowledged that the outlook is highly uncertain, and that the bank will need to adjust its policy as events unfold. The committee's split vote, with one hawk dissenting, signals internal disagreement over the appropriate course of action. Markets will now scrutinize every data point for clues about the timing and magnitude of potential rate hikes.

A Delicate Balancing Act for the BOE

The Bank of England finds itself in a precarious position: it must contain inflation without exacerbating the economic slowdown caused by the energy shock. Bailey's warning that a 'long-lived effect' could embed inflation deeper into the economy underscores the risk of inaction. Yet raising rates too aggressively could choke off growth and strain households already facing higher living costs. The coming months will test the BOE's credibility and its ability to navigate a crisis that combines supply-side disruption with demand-side uncertainty. For now, the bank has chosen to wait, but its governor has made clear that patience has limits. As the war in the Middle East continues to reshape the economic landscape, British households and businesses must brace for the possibility of higher borrowing costs and persistent inflation.

The bottom line

• The Bank of England held rates at 3.75% but signaled potential hikes later this year due to the Iran war's impact on energy prices.
• UK inflation rose to 3.3% in March, driven by fuel costs, and is expected to climb further.
• Governor Andrew Bailey described the situation as a 'negative supply shock' that complicates monetary policy.
• Up to six rate hikes could occur in the most adverse scenario, taking the base rate to 5.5%.
• Over 7 million homeowners face an average £80 monthly increase in mortgage payments over three years.
• The BOE's 8-1 vote revealed internal division, with Chief Economist Huw Pill advocating for an immediate hike.