The Iran conflict destroys hopes of rate cuts! The Bank of England shifts to a hawkish stance, and the market bets on two rate hikes this year.

FX168 Financial News — Over the past three weeks, expectations for UK interest rates have experienced a dramatic reversal. Before the outbreak of the Iran war, currency markets widely anticipated the Bank of England (BoE) would cut rates twice by 2026. Now, market pricing has completely flipped, implying two rate hikes are possible within the year. The pound has surged significantly, reflecting extreme market concerns over inflation prospects.

The BoE’s March decision was hawkish, completely changing market expectations

Earlier this month, markets expected the Monetary Policy Committee (MPC) to vote strongly in favor of a 25 basis point rate cut. However, the Thursday meeting results were unexpected: all nine members voted to keep rates unchanged, marking one of the most unified hawkish signals in recent years.

The committee also sharply raised inflation forecasts: March’s CPI inflation is now expected to approach 3.5%, nearly 0.5 percentage points higher than February’s report; CPI in Q2 is no longer expected to fall to 2.1%, but to stay around 3%. Even if inflation gradually falls back to 2%, the BoE may not consider a rate cut until the third quarter at the earliest.

Market pricing has completely reversed: no rate cuts expected this year, even implying two hikes

The currency market’s reaction has been even more intense, now fully ruling out any rate cuts in 2026, and instead implying that if inflation spirals out of control, the BoE may be forced to hike rates to prevent a second-round effect.

Lloyds Bank senior UK economist Nikesh Sawjani said: “The MPC is more sensitive to the risk of a second-round effect. If evidence shows this risk materializing, the committee is likely to see tightening monetary policy as an appropriate deterrent.”

The BoE tends to view energy shocks as temporary inflation disturbances but is aware that if households and businesses expect continued price increases, it could trigger a wage-price spiral. Workers demand higher wages to maintain living standards, businesses pass on costs to protect profits, ultimately decoupling inflation expectations.

Energy crisis and inflation expectations double hit

Since the Iran war outbreak, Brent crude oil prices have surged over 40%, and European natural gas prices spiked by 35%, directly increasing UK import-driven inflation pressures. Disruptions in the Strait of Hormuz shipping and attacks on Middle Eastern energy facilities threaten long-term structural damage to global supply.

The BoE’s communication still suggests a rate cut later this year, but markets no longer believe this narrative. Investors think inflation data in the coming months is likely to remain above expectations, forcing the BoE to tighten or even hike rates earlier to anchor expectations.

In summary, the energy crisis triggered by the Iran war and the sharp rise in inflation expectations have completely overturned the UK monetary policy outlook. The previously widely expected two rate cuts three weeks ago have been entirely abandoned by the market, replaced by extreme pricing of zero or even two hikes for the year. The pound and savings rates have surged accordingly, reflecting extreme market vigilance over inflation risks. In the coming months, oil prices, Middle Eastern conflicts, and UK inflation data will directly influence whether the BoE is forced to adopt a hawkish stance.

Investors should closely monitor the MPC’s attitude towards second-round effects and actual inflation performance. This energy crisis has evolved from regional conflict into the greatest source of uncertainty for the UK economy and monetary policy.

GBP/USD Daily Chart Source: EasyForex

As of 14:24 Beijing time, March 20 — GBP/USD at 1.3408/09

(Author: Wang Zhiqiang HF013)

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