The UK’s disinflation gains of the past two years risk being reversed by the Middle East war, as the Bank of England voted unanimously to hold rates at 3.75% on Thursday and warned that the US-Israel conflict against Iran could push inflation above 3% and require rate hikes. The monetary policy committee described the conflict as a significant new shock that had threatened to undo the progress made in bringing UK inflation under control. Officials said inflation could rise to approximately 3.5% in March and remain elevated throughout 2026.
The disinflation gains had been hard-won. After the extreme inflation shock of 2022, when UK price growth exceeded 10%, the Bank had pursued a sustained period of tight monetary policy that gradually brought inflation down toward the 2% target. That process had taken nearly two years and had imposed real costs on households through high borrowing costs and squeezed real wages. The prospect of those gains being reversed by a new external shock is deeply frustrating for both policymakers and the public.
Governor Andrew Bailey expressed the Bank’s determination to protect the disinflation gains it had achieved. He said the Bank stood ready to act if the new shock threatened to push inflation back to uncomfortable levels and would use all available tools to ensure a return to the 2% target. His warning about petrol prices and energy bills was framed as evidence that the threat was real and present rather than merely theoretical.
Financial markets moved to price in the reversal risk. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders priced in rate hikes before year end. Analysts noted that the potential reversal of disinflation gains was the most concerning aspect of the Bank’s changed outlook, as it raised the prospect of another extended period of above-target inflation.
The political resonance of potentially reversed disinflation gains is significant. The Bank’s success in bringing inflation down had been a point of credibility for UK institutions in the face of considerable economic turbulence. A reversal of that progress, driven by a geopolitical shock, would test both institutional credibility and public patience with the economic management of the past several years.