Key Takeaways
- Futures markets expect the Bank of England to hold interest rates on March 19, following a rate hold at the February meeting.
- The meeting comes amid fears of an inflationary spike in the UK as the Iran war causes energy prices to soar.
- Markets have rapidly repriced interest rate expectations after previously expecting a cut at the March meeting.
The Bank of England is expected to hold UK interest rates at 3.75% on March 19 as policymakers grapple with the impact of the Iran war on inflation and the economy.
After four interest rate cuts in 2025, followed by a hold at the last meeting in February, futures markets had initially predicted a 0.25 percentage point cut on Thursday.
The outlook has shifted dramatically in the past two weeks, however. Morningstar international economist Grant Slade says traders have reduced expectations of interest rate cuts from the Bank of England since the outbreak of the conflict amid fears over a rise in inflation as energy prices surge.
Now, markets expect the Bank of England to keep rates on hold in March, while cuts which were previously expected later in the year appear to be off the table for now. And the probability of a rate increase in June is around 25%.
The rapid repricing of interest rate expectations has also caused turmoil in bond markets, with UK government bond yields spiking. It has also pushed up some UK mortgage rates above 5%.
Policymakers will have to balance the likely rise in inflation with a slumping economy, however. The latest GDP figures, released on March 13, showed the UK economy unexpectedly stood still in January. This was some way short of economists’ predictions of 0.2% growth for the month.
Despite the slowdown, markets are still expecting the Bank to take a wait-and-see approach as the effects of the Iran war filter through.
How Has Iran War Affected the Long-Term Trajectory of Interest Rates?
Aegon Asset Management investment manager James Lynch says the longer the conflict continues, the longer markets will expect energy prices to be higher and the more unlikely any further interest rate cuts will be.
Looking back at the February meeting, the decision to hold interest rates was a close call, with four of the nine Monetary Policy Committee members voting to cut.
Speaking following the meeting, Governor Andrew Bailey said there “should be scope for some further reduction” this year, which Royal London Asset Management senior economist Melanie Baker says was consistent with a reasonable chance of a cut in March.
“The broad messaging was still that further cuts were coming,” says Baker.
“It seems unlikely to me that they’ll continue to express that view given the rise in energy prices.”
The Bank had also suggested further easing would become a closer call after the four made in 2025, which Baker says suggests now is “simply not a good time to rush” into further cuts.
“It makes sense to take stock for another month or two,” she says.
Moving forward, the future path of interest rates may depend on how policymakers view the energy supply shock.
Ed Hutchings, head of rates at Aviva Investors, says central banks are likely to take lessons from the inflationary spike which followed the covid pandemic, and was then exacerbated by an energy supply shock due to the Russia-Ukraine war.
“With it taking longer than hoped to calm inflationary dynamics that were seen postpandemic, central bankers may be less willing to look through these elevated moves and could be less patient when moving on rates, thereby acting first and asking questions later,” he says.
At one point amid the global selloff, futures markets had begun to predict an interest rate rise later in the year for the Bank of England. However, Peter Goves, head of developed market debt sovereign research at MFS Investment Management, says the cutting cycle is likely paused for now, but not completely derailed.
“Depending on the magnitude and duration of the shock, the Bank of England could resume cutting but only later on in the year.
“We struggle with the idea the Bank of England can or will hike any time soon, which will largely weigh on an already delicate demand backdrop.”
