Everything the UK economy expected of 2025 has been changed by the Iran war, as the Bank of England voted unanimously to hold rates at 3.75% on Thursday and warned that the conflict’s energy price impact had upended the near-term economic outlook. The monetary policy committee described the war as a significant new shock that had replaced expected rate cuts with potential rate hikes, turned a projected inflation return to target into a forecast of renewed price pressures, and created uncertainty where clarity had been building. Officials said inflation could rise above 3% and borrowing costs might need to increase before the end of the year.
The catalogue of changed expectations is extensive. Rate cuts expected by spring have been replaced by potential hikes. Inflation heading toward 2% is now forecast to rise toward 3.5% and remain elevated throughout 2026. Growth expected to benefit from lower borrowing costs now faces the headwind of tighter monetary conditions. Consumer confidence expected to improve as real wages recovered is now threatened by renewed cost pressures.
Governor Andrew Bailey said the Bank had been forced to revise its assessments comprehensively following the outbreak of the conflict. He said the war had been an unwelcome and unexpected shock at a moment when the UK economy had appeared to be moving in the right direction. The Bank’s response was to hold steady and monitor developments, maintaining flexibility in the face of rapidly changing circumstances.
Financial markets reflected the changed expectations sharply. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders moved to price in the new economic reality. Analysts noted that the speed and scale of the expectation change was itself a measure of how significant the Iran war had been as an economic event for the UK.
For policymakers, businesses, and households, the challenge is to adapt their plans to the changed expectations as quickly as possible. The longer it takes to adjust financial decisions and planning assumptions, the greater the potential cost of the adjustment when reality arrives. The Bank’s next meeting will be a critical test of how far the changed expectations translate into changed monetary policy.