The ongoing Middle East conflict has raised concerns over its effect on UK inflation and interest rates in the coming months.
At its most recent meeting, the Monetary Policy Committee (MPC) voted to maintain the Bank of England interest rate at 3.75%. In its report accompanying the decision, the Bank set out some potential scenarios for the coming months.
Here we review what could happen to interest rates in 2026.
📈How interest rates control inflation and dampen growth?
The Bank is tasked with using interest rates to influence inflation, with the target of keeping inflation below 2%. Inflation was 3.3% in March. When inflation is above target, increasing interest rates encourages less spending, which reduces demand and helps to keep price rises in check.
Raising interest rates can dampen growth, though it may already be negatively impacted by the conflict. In other words, increasing interest rates can have a doubly dampening effect.
Earlier in 2026, inflation appeared to be on a downward trend but the conflict in the Middle East has affected oil supplies and prices in a way that makes increased inflation likely.
The Bank of England appears to have adopted a ‘wait and see for now’ policy, as they look to see the extent of the inflationary increases. It is likely to take a few more weeks for the effects of price changes to work their way through the system.
🤔Potential scenarios ahead
The MPC’s report considers some potential scenarios and how the Bank may respond.
- Scenario A: Oil prices peak at $108 per barrel in 2026 before falling back to below $80 by early 2027. Gas prices similarly peak and fall back within a similar time frame. Secondary effects on inflation, where wages and prices of other items rise, are limited.
- Scenario B: Prices peak in a similar time frame to Scenario A but take longer to fall back. This has a more prolonged, but modest, effect on inflation.
- Scenario C: Energy prices rise sharply and stay high for a prolonged period. Inflation rises to over 6% by early 2027.
Scenario C is the most adverse scenario of the three and modelled reactions to this scenario suggest that multiple interest rate rises would be needed, perhaps reaching 5.25%, to bring inflation down more quickly.
The MPC note that the effect that this would have on growth, which is also forecast to have weakened, would need to be considered when deciding on actual rate rises.
Another possible alternative to these scenarios is that the situation in Iran resolves quickly, prices come back under control and there is no effect on interest rates.
The MPC’s report does not indicate which scenario is more likely, however, Andrew Bailey, the governor of the Bank of England, told the BBC that he considered scenario B to be the most likely.
☝🏻Rates have still gone up
Although the Bank has not yet adjusted the official rate, interest rates on loans and fixed-rate mortgages have already increased in the weeks since the conflict started based on lenders’ expectations of what will happen in 2026.
This has already affected the housing market, with some buyers finding that their mortgage offer has collapsed or become unaffordable, and those renewing fixed-rate deals are finding that their options have suddenly become more expensive.
Clearly, there continues to be uncertainty about the scale and effect of the conflict on household and business finances. As ever, forecasting cash flows and planning for how changes in interest rates will affect your business’ finances remain important. If you need any help with this, please do get in touch. We would be happy to help you.
For more info, see: https://www.bankofengland.co.uk/monetary-policy-report/2026/april-2026