Bank of England warns: Iran conflict could cause energy shock and force rate hikes

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LONDON — U.S. President Donald Trump’s shadow is set to loom over the British economy as the Bank of England on Thursday warned fresh conflict in Iran could send prices soaring.

New U.K. Prime Minister Andy Burnham took office last week with a flurry of cost-of-living announcements — but it’s the U.S. president’s policies that risk having the biggest potential knock-on to U.K. inflation, according to the central bank.

The Bank’s Monetary Policy Committee decided Thursday to keep interest rates on hold but warned the stop-start conflict in the Middle East could become a persistent energy shock and force rate hikes.

“Inflation has fallen faster than we’ve expected, but the conflict in the Middle East continues to mean high and volatility energy prices,” said BoE Governor Andrew Bailey.

In the U.K. and EU, the U.S.-Iran temporary ceasefire brought hopes to policymakers that the impact of the conflict could be short-lived, with signs of resilience in the economy, amid lower services and food inflation, slowing wage growth and a soft labor market.

The European Central Bank was the first major central bank to raise rates in June in a bid to ensure price stability, but held in its July meeting after eurozone inflation came in lower than expected last month. The U.K., too, saw inflation falling in June — to 2.6 percent — before the conflict re-escalated.

But, with Britain predicted to take the biggest economic hit of any major country from the Iran war, the path ahead appears particularly uncertain, according to the central bank’s projections, and will depend just how far energy prices spiral driven by the on-again off-again nature of the war.

“The U.K. is an open economy, so obviously we look at world conditions and of course in some ways never more so than at the moment, given what’s going on in the wider world and particularly the conflict in the Gulf,” Bailey told journalists in a press conference following the MPC decision.

The central bank modeled various scenarios to assess the possible impact of the ongoing war. In an adverse scenario, where there is a repeated re-escalation of the conflict, prices start sticking throughout the economy and inflation peaks at 4.5 percent in the second quarter of 2027.

This would lead to rate hikes and leave inflation above target in 2028.

Under a central projection, which is designed to present a reasonable baseline scenario, inflation would peak at 3.2 percent in the last quarter of this year and drop to below the Bank’s 2 percent target by 2028.

A milder case, where there is a durable end to the war, would have inflation even lower, peaking at 3 percent at the end of the year, before again dropping back below 2 percent.

The MPC was split 6-to-3 on the decision with Catherine Mann flipping to vote with the two hawks for a rate rise of 0.25 percent.

“The key change in the environment for my decision is the collapse of the US-Iran Memorandum of Understanding, the widening of the Middle East conflict, and the associated volatility in energy prices,” she said in comments attached to the decision.

Burnham’s cut to VAT on energy bills and £2 cap on bus fares were factored into the Bank’s expectations. But household utility bills are projected to only contribute 0.1 percentage points to inflation.

Aside from Trump, the Bank also warned inflation driven by investment in artificial intelligence components, or higher food prices from the impact of the El Niño weather phenomenon, could become shocks in their own right.