The Iran war has pushed the inflation outlook above the Bank of England’s comfort zone, prompting a unanimous decision to hold rates at 3.75% on Thursday while warning that borrowing costs could rise if the energy price shock proves persistent. The monetary policy committee said the conflict had created a new and significant inflationary pressure through rising global oil and gas prices, threatening to push UK inflation above 3% and keep it there well into 2026. The announcement marked a clear departure from the comfort of the gradual disinflation that had been proceeding before the war began.
The comfort zone for the Bank of England is centred on its 2% inflation target, with some tolerance for temporary deviations in either direction. The Bank had been operating comfortably within that framework as inflation fell from its 2022 peak toward target. The Iran war’s energy price impact has pushed the inflation outlook well outside that comfort zone, creating a situation where the Bank must decide how forcefully to respond to an externally driven price shock.
Governor Andrew Bailey said the Bank would not allow inflation to remain above target indefinitely simply because the cause was external rather than domestic. He acknowledged the petrol price rise as an early and visible sign of the discomfort ahead and warned that household energy bills could add to that discomfort if supply disruption continues. The Bank stood ready to act but was choosing to hold and gather more evidence.
Financial markets reflected the changed comfort zone dynamic. UK gilt yields rose, the FTSE 100 fell, and the pound gained against the dollar as traders priced in rate hikes before year end. Analysts noted that the shift in the Bank’s comfort zone had significant implications for the UK’s broader economic environment and for the government’s growth plans.
The practical implication of an above-comfort-zone inflation outlook for UK households is a continued period of financial pressure. Real wages will face renewed downward pressure if inflation rises and nominal pay growth remains moderate. Mortgage costs will be higher if the Bank raises rates. And energy bills could climb if the war’s disruption to global supply persists. The Bank’s willingness to raise rates into this environment will be a defining test of its commitment to its inflation mandate.