The prospect of UK interest rate cuts has all but evaporated following a sharp escalation of tensions in the Middle East, with financial markets now pricing in no reductions for the remainder of 2026 and a potential rise by next June. The Bank of England, which just weeks ago was widely expected to cut rates at its March meeting, now faces a dramatically altered inflation landscape driven by soaring energy prices and geopolitical instability.
Markets data released Monday shows investors predict the Bank will hold its base rate at 3.75% through the end of the year, with a 99% probability of no action at the upcoming March 19 meeting. That marks a sharp reversal from just days earlier, when an 80% chance of a cut had been priced in. The conflict has exposed how quickly global events can upend monetary policy expectations, and how vulnerable the UK economy remains to external shocks.
Bond Yields Spike to Levels Not Seen Since April 2025
The most immediate signal of market anxiety came from UK government bonds. Two-year yields climbed to 4.129% on Monday, up sharply from 3.52% in the days before hostilities began. According to Reuters, the move was on track for the largest single-day increase since Liz Truss’s ill-fated mini-budget in 2022, an episode that triggered a sterling collapse and a dramatic bond market selloff.
The yield surge carries direct consequences for ordinary borrowers. UK mortgage lenders have already begun raising rates on home loans, with data from Moneyfacts showing the average two-year fixed residential mortgage climbing to 4.87% on Monday, up from 4.84% on Friday. The five-year fix nudged up to 4.98%. For households already stretched by years of elevated borrowing costs, the prospect of a further rate increase next summer adds significant pressure.
Oil Shock Threatens to Reignite Inflation Across Europe
At the heart of the market turmoil is the near-closure of the Strait of Hormuz, the critical chokepoint through which roughly 20% of global oil supply passes. Brent crude hit $119 a barrel on Sunday night before retreating to $104 after G7 finance ministers announced an emergency online meeting to discuss releasing strategic reserves.
Chris Beauchamp, chief market analyst at IG, noted that investors had remained “remarkably complacent” in the early days of the conflict but were now rushing to reduce risk exposure. European stock markets opened sharply lower, with the FTSE 100 dropping nearly 2%, Germany’s DAX falling 2.3%, and the Paris CAC sliding 2.5%, before partially recovering through the morning session.
According to Anna Titareva, an economist at UBS Investment Bank, only two of the Bank of England’s nine monetary policy committee members are now likely to vote for a cut at the March meeting. The majority, she said, will be focused on the inflationary implications of higher energy prices, a concern shared by the European Central Bank, which markets now give a 70% probability of delivering two rate hikes by year’s end.
Beauchamp offered a note of caution on that trajectory, warning that policymakers risk overreacting to a supply-side shock. “This is a supply-driven shock, not some huge surge in demand,” he said, cautioning that premature rate hikes could tip the economy into a deeper recession.
