The Iran conflict has rewritten the UK economic script for 2025, turning an anticipated year of rate cuts and gradual recovery into a period of inflation anxiety and potential tightening, as the Bank of England voted unanimously to hold rates at 3.75% on Thursday and warned of rising energy costs. The monetary policy committee described the US-Israel conflict against Iran as a significant new economic shock that had materially changed the near-term outlook for UK prices. Officials warned that inflation could rise above 3% and require rate hikes in the months ahead.
The script that had been written for 2025 involved a gradual reduction in interest rates as inflation cooled toward the Bank’s 2% target, providing relief to homeowners, stimulating business investment, and supporting the government’s growth agenda. The Iran war has torn up that script by sending global energy prices sharply higher and introducing a new inflationary force that the Bank cannot control directly but must respond to through monetary policy.
Governor Andrew Bailey acknowledged the scale of the script change, describing the war as a new and unwelcome shock at a delicate moment. He said the Bank was committed to its inflation target and would act if necessary, pointing to rising petrol prices as evidence that the shock was already real and present in the UK economy. His message for the public was one of vigilance rather than alarm.
Financial markets moved to price in the new script. UK gilt yields rose, the FTSE 100 fell, and the pound gained against the dollar as traders adjusted their expectations for UK monetary policy. A June rate hike is now widely anticipated, with a second possible before December. Mortgage rates for five-year fixed deals climbed to their highest levels since early 2025.
The political consequences of the rewritten script are significant. A government that had been planning to run on an economic recovery story now faces the possibility of delivering a message about managing an external shock. Chancellor Reeves will need to adapt the government’s economic narrative and potentially its policy toolkit as the Bank signals that the easy money era is not returning as quickly as hoped.