UK Rate Cuts Unlikely Amid Conflict

Financial markets now predict the Bank of England will maintain its base rate at 3.75% for the remainder of the year, with a potential increase to 4% by June next year, reversing earlier expectations for rate cuts. This shift, observed on Monday, follows the escalation of the US-Israel war on Iran, which has driven oil prices above $100 per barrel and caused a surge in bond yields.

Prior to the conflict, markets had priced an 80% probability of a rate cut at the Bank's March 19 meeting. However, current market data indicates a 99% probability of a hold at that meeting and no rate cuts through 2026.

UK two-year bond yields rose to 4.129% on Monday, up from 3.52% before the conflict, marking the highest level since April 2025. This increase in bond yields, a proxy for interest rates, suggests higher mortgage rates for UK homeowners, with the average two-year fixed residential mortgage rate rising to 4.87% and the five-year fix to 4.98%.

European stock markets also experienced significant declines, with the UK's FTSE 100 dropping 1.9% and Germany's Dax falling 2.3% in early trading. The conflict's impact on oil supply, particularly through the Strait of Hormuz, has fueled concerns about rising inflation in the UK and Europe, potentially compelling central banks to further tighten monetary policy.