UK interest rates are not expected to be cut this year and could even rise next summer, according to financial markets, in a dramatic reversal of forecasts ahead of the US-Israel war with Iran.
Market data on Monday showed investors predicting the Bank of England will most likely keep its base rate at 3.75% for the rest of the year and raise it to 4% next June.
Before the war with Iran began, a rate cut at the Bank’s next meeting on March 19 had an 80% chance, but policymakers are now expected to wait to see how the conflict plays out, with a 99% chance of the meeting going ahead and no rate cuts for the rest of 2026, markets indicate.
Statements by Iranian leaders and Donald Trump over the weekend showed that both sides in the conflict were prepared to fight for several more months, leading financial markets to post sharp declines.
Two-year UK bond yields rose to 4.129%, up from 3.52% in the days before the conflict began and the highest since April 2025.
The yield, which is an indicator of the interest rate, on two-year government bonds was on track to record the biggest one-day rise since Liz Truss’ mini-Budget in 2022, Reuters reported. Truss’s plans for unfunded tax cuts and support for energy bills caused bond yields to rise and sent the pound to a record low.
The potential rise in interest rates raises the prospect of higher and longer mortgage rates for UK homeowners. UK mortgage lenders have started raising the interest rate on home loans in a further blow to the living standards of struggling households.
On Monday, Moneyfacts data showed the average two-year fixed residential mortgage rate was 4.87%, up from 4.84% on Friday, while the average five-year fixed rate was 4.98%, down from 4.96%.
European stock markets plunged after the open on Monday. The UK’s FTSE 100 fell 200 points or 1.9% to 10,087 points before recovering to 10,170 at 10am.
Germany’s Dax also regained some lost ground after falling 548 points or 2.3% to 23,043 points in early trading, while Paris’ CAC fell by the most: 2.5%.
Chris Beauchamp, chief market analyst at IG, said stock markets had woken up to the implications of the Iran war, which has left the Strait of Hormuz, through which around 20% of the world’s oil supply passes, effectively closed, potentially for a long period.
Brent crude oil hit $119 a barrel on Sunday night before falling back to $104 after it was announced that G7 finance ministers would meet online on Monday to discuss opening up emergency oil reserves.
Beauchamp said: “Having remained remarkably complacent last week, it looks like the race for the exits has begun in earnest.
“Even high-flying defense stocks are taking a hit in London today, a sign that investors are no longer worried about potential gains but are instead focusing on protecting their gains, opting to sell now and stay out of the volatility for now.”
Investors fear that rising oil prices will push up inflation in the UK and Europe, which import most of their energy and fuel. A rise in inflation could force central banks to freeze interest rates and even raise them again next year.
Anna Titareva, an economist at investment bank UBS, said the majority of the bank’s monetary policy committee (MPC) will be concerned about rising energy prices. He said only two of the committee’s nine members are likely to vote in favor of a cut that was expected before the crisis hit.
Beauchamp said the minority in the MPC would adopt a rational response to imported inflation, which would damage the economy’s growth potential.
He said: “This morning we’ve already seen markets start to price in rate hikes by the European Central Bank and the Bank of England. But that seems strange given the huge impact that is about to be felt on consumer spending – this is a supply-driven shock, not a huge surge in demand.
“Policymakers may have learned the wrong lesson from 2021 and risk triggering a much deeper recession if they are too willing to raise rates.”
The ECB is now expected to raise European rates in July. Markets imply there is now a 70% chance the ECB will make two 25 basis point (0.25 percentage point) rate hikes this year, compared to the one priced in on Friday.
