Economists have revised their UK inflation forecasts upward following a surge in energy prices driven by the war in Iran, complicating the Bank of England’s upcoming interest rate decision.
According to a compilation of independent forecasts published by the Treasury on Wednesday, annual inflation is now expected to reach 2.6% in the fourth quarter—well above the Office for Budget Responsibility’s (OBR) estimate of 1.9% issued earlier this month.
Berenberg economist Andrew Wishart has raised his UK inflation forecast for 2026 to 2.6% from 2.4%, assuming a scenario in which the conflict is resolved quickly and the Strait of Hormuz reopens within weeks.
Even under a short-lived conflict, higher fuel prices in the near term and rising utility bills later in the year are likely to delay inflation’s return to the central bank’s 2% target. “A more prolonged conflict would push that timeline well beyond 2027,” Wishart said.
The Bank of England is expected to hold its rate at 3.75% on Thursday, but financial markets are already pricing in the possibility of an increase by the end of the year. This marks a reversal from pre-war expectations, when investors had anticipated two quarter-point rate cuts.
As market expectations for interest rates have shifted, the average two-year fixed mortgage rate rose to 5.3% on Wednesday—the highest level since February 2025—up from 4.83% at the start of March, according to Moneyfacts data.
Pimco economist Peder Beck-Friis highlighted the high degree of uncertainty surrounding the outlook, which hinges on the trajectory of energy prices. “If prices remain at current levels, the impact on inflation could be around 1 percentage point, bringing the overall rate close to 3% by year-end,” he said.
Last week, OBR economist David Miles also noted that if current elevated oil and gas prices persist, UK inflation could end the year at around 3%.
At the same time, economists have lowered their growth forecast for 2026 to 0.9%, down from 1.1% in February, according to the Treasury report. This figure falls below the OBR’s 1.1% estimate but broadly aligns with the Bank of England’s latest projections.
Unemployment is also expected to rise to 5.3% by the end of the year, up from 5.2% previously.
Ellie Henderson of Investec warned that the direct impact of higher energy prices is not the only source of risk. Rising natural gas costs—used in fertilizer production—could trigger a chain reaction in food prices, while companies facing higher energy bills are likely to pass those costs on to consumers. “The risks of accelerating inflation are becoming increasingly concerning,” she said.