By David Prosser*
Where will interest rates in the UK end the year? The short answer, according to current levels of pricing in the financial markets, is higher than they are today, but not as high as some economists had feared when the international conflict in the Middle East intensified.
It’s important to be realistic. The outlook for interest rates remains highly uncertain –no-one can be sure how events in the Middle East will unfold over the next few days and weeks, let alone in the coming months. The agreed ceasefire provides very welcome respite, but it’s not at all certain to hold. The prospects for peace still feel very fragile.
Still, two weeks ago, pricing on the UK’s money markets suggested traders expected the Bank of England’s Monetary Policy Committee to raise interest rates three times before the end of the year to curb the additional inflation caused by the war. That would take the base rate from 3.75% today to 4.5%. Today, by contrast, markets are pricing in just one rate increase, to 4%. **
Three possible scenarios for interest rates
The MPC, which holds its next meeting on 30 April, will certainly be poring over the latest economic data in even more detail than usual. They’ll be looking for signs that the inflationary impacts of the war are starting to feed through into secondary effects such as accelerated wage growth; that would see the MPC take a more hawkish view of monetary policy.
Broadly speaking, there are now three possible directions of travel. But to be clear, there is no avoiding the impact of higher energy prices on inflation. The spike in oil and gas prices caused by the war has already resulted in higher petrol prices, rising utility bills and increased costs in industries ranging from agriculture to aviation. The hope now, if the ceasefire holds and peace talks go well, is that energy prices will fall back. The price of a barrel of oil, for example, currently stands at around $95 – that’s below the peak of $109 seen prior to the ceasefire, but well above the $70 before war began.
In an ideal world, energy prices will now fall sharply, but that seems optimistic given the damage caused to many oil and gas facilities in the Middle East, as well as ongoing disruption in the Strait of Hormuz.
The next best outturn would be for expectations about inflation to dampen as people grow more confident that prices will trend downwards over time. That’s important because when people are less worried about inflation to come, they’re less likely to push for more generous pay settlements; the Bank’s fear there is of a sharp increase in wage costs that leads to increased costs across the whole economy and drives an inflationary spiral.
The third possible scenario is that energy prices remain elevated, particularly if peace doesn’t hold. The longer that remains the case, the more danger there is of a significant and sustained increase in inflation. The OECD has warned that the UK is more exposed than any other Western nation to rising energy prices, and the International Monetary Fund says the UK is particularly vulnerable to adverse impacts from the closure of the Strait of Hormuz. In which case, significant interest rate increases would become ever more likely.
The impact on savings and mortgages
There’s no doubt that war has changed the likely trajectory of interest rate increases this year. As recently as early February, the markets thought it likely that the MPC would cut rates at least once during 2026 and probably twice.
Financial markets don’t always get predictions right. Economists remain divided about the likely impact of the war in the Middle East, on UK interest rates. And Andrew Bailey, the Governor of the Bank of England, said last month that traders were “getting ahead of themselves” by assuming the war would lead to rate hikes. But very few experts now see much likelihood of rate reductions – unless energy prices really do fall back very quickly and the war’s impact on UK inflation is much less damaging than expected.
What does that mean for customers of banks and building societies – individuals and organisations with savings accounts and mortgage borrowing? Well, it may be difficult to get a clear answer in the very short term.
Naturally, banks and building societies will pass on interest rate rises to savers and borrowers. So, if these increases are now more modest than was previously expected, the impact of the war on savings rates and mortgage costs will also be less significant.
However, banks and building societies are as uncertain as everyone else about what will happen next. They are therefore taking a very cautious approach to pricing. For example, mortgage lenders have withdrawn hundreds of their most competitively priced home loans in recent weeks but not necessarily replaced them with more expensive products. They’re in wait-and-see mode – and likely to remain so for some time to come.
In short, it’s not yet possible to chart a likely course for savings and mortgages with any real confidence. The longer the ceasefire holds – and the more hope there is for an enduring peace – the more we’ll start to see some stability. Interest rates still look likely to edge upwards, but perhaps not markedly so.
Still, don’t assume the volatility is over. There will undoubtedly be more twists and turns to come in the Middle East, with plenty of bad days as well as good. And that will inevitably affect the calculations we’re all making about the consequences for our own finances.
* This article is written by David Prosser, a freelance journalist and personal finance expert. Although this article may contain helpful information and tips, this is not personal advice. You may wish to seek advice from a financial advisor if you are unsure what’s best for your own personal circumstances.
** Market pricing may move in either direction, this is not fixed.