Key facts
- The Bank of England warned that a prolonged US-Iran conflict could push UK inflation to 4.5% by the second quarter of 2027.
- The central bank decided to keep interest rates on hold.
- Inflation is projected to peak at 3.2% in the last quarter of 2026 under a central scenario.
- A milder scenario predicts inflation peaking at 3% by the end of 2026.
- MPC member Catherine Mann voted for a rate hike due to Middle East conflict and energy price volatility.
The Bank of England has warned that escalating conflict between the U.S. and Iran could significantly impact the British economy, potentially driving inflation to a peak of 4.5% in the second quarter of 2027. This warning comes as new UK Prime Minister Andy Burnham takes office amidst cost-of-living concerns.
Governor Andrew Bailey stated that while inflation has fallen faster than expected, the ongoing conflict in the Middle East presents a risk of high and volatile energy prices. The Bank's Monetary Policy Committee decided to hold interest rates steady but acknowledged the potential for persistent energy shocks. The UK, being an open economy, is particularly susceptible to global conditions, especially the conflict in the Gulf.
The central bank modeled several scenarios. In an adverse scenario with repeated conflict re-escalations, inflation could become entrenched and peak at 4.5% in Q2 2027, potentially leading to rate hikes and inflation remaining above target in 2028. A central projection forecasts inflation peaking at 3.2% in the last quarter of 2026, falling below the 2% target by 2028. A milder scenario, assuming a durable end to the war, would see inflation peak at 3% by year-end before returning below target.
The MPC vote was split 6-to-3, with member Catherine Mann voting for a 0.25% rate increase, citing the collapse of a US-Iran Memorandum of Understanding, the widening conflict, and associated energy price volatility. The Bank factored in Prime Minister Burnham's measures, such as a VAT cut on energy bills and a cap on bus fares, but noted household utility bills would only contribute marginally to inflation. The Bank also highlighted potential inflation risks from investment in AI components and higher food prices due to the El Niño weather phenomenon.