The Iran war has delivered the UK economy its most unwelcome economic surprise in years, with the Bank of England voting unanimously to hold rates at 3.75% on Thursday and acknowledging that the conflict had fundamentally disrupted a positive trajectory that had been building through the early months of the year. The monetary policy committee described the war as a significant new shock that had arrived at a particularly inconvenient moment, threatening to reverse progress on inflation and push interest rates in the wrong direction for households and businesses. Officials warned that the conflict could push inflation above 3% and require rate hikes before year end.
The unwelcome nature of the surprise stems from its timing and its direction. The UK economy had been making genuine progress on the twin challenges of inflation and growth, with price pressures easing and the case for rate reductions building. The war has interrupted that progress at precisely the moment when some relief from years of financial strain had appeared to be arriving. For UK households that had been anticipating lower mortgage costs and cheaper energy bills, the surprise is particularly cruel.
Governor Andrew Bailey acknowledged the disruption to what had been improving conditions. He said the Bank had been expecting a more straightforward period of gradual monetary normalisation and that the war had comprehensively altered that expectation. His message was that the Bank would adapt to the changed circumstances and act as necessary, but that the change was regrettable in its timing and consequences.
Financial markets moved sharply to reflect the unwelcome surprise. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders repriced the UK’s monetary policy outlook. Analysts noted that the surprise element of the change was itself costly, as it required rapid adjustment of financial plans and expectations that had been built for a different environment.
For the government, the most unwelcome economic surprise creates a political challenge of managing expectations that had been set for a more positive period. The narrative of improving economic conditions that had been building through the start of the year has been disrupted, and replacing it with a credible account of how the government will manage the new challenges requires both communication skill and practical policy action.