Bank of England’s Rate-Cut Plans Thrown Into Doubt by Iran War and Energy Shock

The Bank of England’s interest-rate setters walked out of their February meeting believing the long inflation shock was finally under control.

Consumer price growth was easing, wage pressures were cooling and the economy was barely growing. A narrow majority judged there was no need to rush another cut. “On the basis of the current evidence, Bank Rate is likely to be reduced further,” the Monetary Policy Committee said in its summary, while warning that future moves would be “a closer call.”

Three weeks later, war in Iran and attacks on tankers in the Strait of Hormuz sent oil and gas prices surging, upending those assumptions and reopening the Bank’s most difficult trade-off: how to balance resurgent inflation risks against a weak domestic economy.

The nine-member MPC voted 5–4 on Feb. 4 to leave Bank Rate at 3.75%, one of the narrowest possible splits. Governor Andrew Bailey and four colleagues backed the hold. Four others pushed for a quarter-point cut to 3.5%, arguing that monetary policy remained too tight as unemployment rose and growth stalled.

That close call is now the Bank’s last major snapshot of a prewar world.

A knife-edge vote

Minutes of the February meeting, published Feb. 5, show a committee already divided over how quickly to unwind two years of aggressive tightening.

Those voting to hold — Bailey, Megan Greene, Clare Lombardelli, Catherine L. Mann and Huw Pill — focused on the risk that underlying inflation could prove more stubborn than headline figures suggested. Services inflation and pay growth had begun to ease but were still above levels the Bank associates with its 2% target.

Cutting too fast “could leave policy settings that were too loose,” the minutes said, and a subsequent need to raise rates again “could be costly.”

The minority — Deputy Governor Sarah Breeden, external member Swati Dhingra, Deputy Governor Dave Ramsden and external member Alan Taylor — saw the balance of risks differently. They judged the danger of entrenched inflation had “receded materially” and argued that the greater threat now lay in weak demand, a wider output gap and a labor market that “had continued to loosen.”

For them, Bank Rate, reduced by 1.5 percentage points since August 2024, was still “too restrictive” for an economy that had barely expanded for months.

Both camps agreed that some further easing was likely, but not on when to move next.

Inflation falling, growth flat

Data in hand at the February meeting painted a picture of disinflation alongside stagnation.

Headline consumer price inflation dropped to 3.0% in January from 3.4% in December and 3.8% in September, the lowest rate in nearly a year. Core inflation, which strips out volatile food and energy prices, eased to around 3.1%.

In its accompanying Monetary Policy Report, the Bank projected inflation would fall “back to around the 2% target from April,” reflecting earlier declines in wholesale energy prices and changes to regulated charges and taxes announced in the 2025 Budget.

At the same time, the real economy was barely moving. Official figures show gross domestic product grew about 1.3% in 2025, with quarterly growth of around 0.1% late in the year. GDP was flat in January. The MPC judged that underlying output was running below potential, with a “slightly wider output gap” than it estimated in November.

The labor market was loosening. Unemployment had climbed to just over 5%, the highest in roughly five years, and vacancies had fallen below pre-pandemic levels. Pay growth was slowing from peaks above 6%–7%, with surveys pointing to 2026 wage settlements around 3.5%, closer to rates consistent with 2% inflation.

Against that backdrop, the February minutes said “the risk from greater inflation persistence had continued to become less pronounced, while some risks to inflation from weaker demand and a loosening labour market remained.”

Bailey told colleagues he did not see “big new shocks” hitting the economy at that point. The guidance that followed — that rates were likely to be reduced further, but that each cut would be a closer judgment — helped cement a prewar market narrative that the Bank was on a cautious easing path through 2026.

War and an energy shock

That narrative shifted abruptly on Feb. 28, when a U.S.- and Israeli-led operation against Iran triggered a wider conflict. Iran responded with drone and mine attacks on shipping, disrupting traffic through the Strait of Hormuz, the narrow waterway through which around a fifth of global oil and liquefied natural gas normally flows.

Benchmark Brent crude climbed from the mid-$60s per barrel in late February to above $80 in the days after the first strikes, then toward $100 as hostilities intensified. European gas prices jumped sharply, and Britain’s benchmark gas contract rose by more than 50%.

Analysts said those moves threatened to reverse the decline in household energy bills that the Bank of England had been counting on to push inflation down to target. Forecasters have warned that the government’s domestic price cap on gas and electricity could rise by 10% to 20% in July if wholesale prices remain elevated, potentially driving U.K. inflation back above 5% later in the year.

Fuel costs have also increased. Average petrol and diesel prices climbed to their highest levels since mid-2024, and heating oil costs for off-grid households have soared compared with a year earlier, according to industry data and consumer groups.

Financial markets quickly reassessed the interest-rate outlook. Yields on two-year U.K. government bonds, which are sensitive to expectations for Bank Rate, recorded one of their sharpest daily increases since 2025 as investors priced out much of the anticipated easing. Before the conflict, futures markets implied around an 80% chance the MPC would cut rates again at its March 19 meeting. Within days, that probability had fallen sharply, and some analysts began to forecast no cuts at all this year, with a risk that rates might instead need to rise.

One major newspaper described the shift as “a dramatic reversal of forecasts before the US-Israel war on Iran.”

A sharper trade-off

The Iran and Strait of Hormuz crisis has forced the Bank of England back into a familiar dilemma: how to respond to an external supply shock that pushes up prices and squeezes real incomes, without stalling an already fragile recovery.

Textbook monetary policy cannot prevent an oil price spike. Central banks can either tolerate the first-round impact on inflation, focusing on whether wages and domestic prices respond, or raise rates — or delay cuts — to signal determination to keep overall price growth near target.

The February majority’s concern about inflation persistence now sits alongside evidence of a new, imported source of price pressure. If higher energy costs feed through into expectations and wage bargaining, members who argued for caution may feel vindicated in resisting calls for rapid easing.

At the same time, the minority’s warnings on growth and slack have become more pressing. Higher bills and fuel costs act like a tax on households and businesses, hitting discretionary spending and profitability. Sectors such as retail, hospitality and energy-intensive manufacturing, already under strain, are exposed to any renewed downturn in demand.

Charities and anti-poverty groups say another rise in energy prices risks pulling more households into fuel poverty, particularly those on prepayment meters or in poorly insulated homes. Youth unemployment is already at multi-year highs, and regional economies reliant on heavy industry could be disproportionately affected if firms retrench.

The government faces difficult choices of its own. Chancellor Rachel Reeves is under pressure from opposition parties and consumer advocates to cushion the blow from higher energy and food prices. Additional fiscal support, such as subsidies or targeted transfers, could limit the hit to living standards but would also influence demand and potentially complicate the Bank’s task.

What comes next

When the MPC meets again on March 19, it will do so in a landscape that looks very different from the one it surveyed in early February.

Committee members will have to weigh their prewar assessment — that inflation was on course to fall to target and that Bank Rate was likely to decline further — against new projections built on higher energy and possibly higher food prices. They will also assess whether the latest data show any shift in inflation expectations or wage demands in response to the conflict.

The options range from holding rates steady while signaling a willingness to “look through” the initial inflationary impact of the shock, to emphasising readiness to tighten policy again if second-round effects threaten to take hold. Either way, the path of interest rates that only weeks ago appeared to slope gently downward now looks far less certain.

For households and businesses that had hoped 2026 would finally bring relief from years of elevated borrowing costs and volatile bills, the timing could hardly be worse. The Bank of England’s last prewar rate decision shows how close it already was to moving faster on cuts. The events since suggest that, once again, factors far beyond Threadneedle Street may determine how long the pain of high prices and high rates lasts.