Interest rates in the UK could be pushed back up above 4% if war in the Middle East prompts a persistent spike in oil and gas prices, an economic think tank has warned.
The National Institute of Economic and Social Research (Niesr) said the Bank of England will have to contend with a “shock” to energy costs which could “cause problems for Rachel Reeves”.
Oil and gas prices have spiked since the US-Israel war with Iran intensified, leading to disruption to supplies of the commodities.
Iran has threatened to block key shipping route the Strait of Hormuz in response to strikes, while Qatar said it had halted production of liquified natural gas on Monday following attacks on its plants.
The price of Brent crude oil has risen by about 15% since the outbreak of fighting over the weekend, and analysts said the European benchmark for natural gas has soared by about three quarters.
Nevertheless, prices rises were steadying on Wednesday following spikes over the start of the week.
But Niesr published analysis showing that rising energy costs could push up in inflation in the UK.
The research institute drew up two scenarios involving oil prices rising a further 30%, and gas prices a further 50%.
If this price spike is temporary, and energy prices begin to normalise after three months, then Consumer Prices Index (CPI) inflation for 2026 could rise by about 0.3 percentage points relative to previous forecasts from its February economic outlook.
In this case, it expects the Bank of England and other central banks to look past the temporary energy shock and it would have little baring on interest rates – although Niesr acknowledged that policymakers could still take it into account.
In the second scenario, energy price rises persist for a year before steadying, which it predicts would push up CPI inflation by 0.7 percentage points in 2026, and by 0.5 percentage points in 2027, and also weigh on UK gross domestic product (GDP) by 0.2 percentage points in 2026 and 0.3 percentage points in 2027.
Under this scenario, Niesr said interest rates in the UK could increase by about 0.8 percentage points compared to its previous forecasts.
Niesr had said, in its February economic outlook, that it was expecting the Bank to cut interest rates twice this year, from the current 3.75% level, to settle at about 3.25%.
The new analysis suggests the Bank could be forced to push rates back up above 4%.
Ed Cornforth, an economist for Niesr, said: “The conflict in the Middle East will have material implications for the economic outlook.
“The Bank of England will have to contend with a shock to global energy prices, with the question of persistence hanging over their heads.
“This will cause problems for Rachel Reeves as financing costs increase, putting further pressure on an already precarious fiscal outlook.”
Expectations among traders in the financial markets that the Bank will deliver a cut to interest rates when it meets next week have dropped sharply since the weekend.
James Smith, developed markets economist for ING, said: “Investors have slashed expectations for a March rate cut from the Bank of England. Markets are pricing it with just a 20% probability, down from 80% pre-conflict.”
However, the economist said he still thinks that UK interest rates “have further to fall”, even if the next reduction is pushed back.
“We now expect the next Bank of England cut in April though March is still a distinct possibility if Middle Eastern tensions rapidly de-escalate,” he said.
“With the jobs market still under pressure, further easing is still more likely than not.”
