Interest rates in the United Kingdom could rise above 4% if conflict in the Middle East results in a sustained increase in oil and gas prices, according to the National Institute of Economic and Social Research (NIESR).
The think tank highlighted that the Bank of England may face a new inflationary “shock” from rising energy costs, which could complicate Chancellor Rachel Reeves’s economic plans.
Energy markets have become volatile since tensions escalated between the United States, Israel, and Iran.
Iran has threatened to block the Strait of Hormuz, a vital global shipping route, while Qatar Energy has suspended liquefied natural gas production following reported attacks on its facilities.
Since the outbreak of fighting, the price of Brent crude oil has increased by approximately 15%, while European gas prices have surged by around 75%.
However, markets showed signs of stabilising midweek after experiencing sharp initial spikes.
NIESR modelled two scenarios to analyse the impact of rising oil and gas prices.
In the first scenario, where energy prices spike but then normalise after three months, Consumer Prices Index (CPI) inflation in 2026 would increase by about 0.3 percentage points relative to previous forecasts. In this case, the Bank of England would likely “look through” the temporary shock, meaning interest rate plans would remain largely unchanged.
In the second scenario, where elevated energy prices persist for a full year, CPI inflation could be 0.7 percentage points higher in 2026 and 0.5 percentage points higher in 2027. Additionally, 0.2 percentage points would reduce UK GDP in 2026 and 0.3 percentage points in 2027.
Under this prolonged shock, NIESR indicated that UK interest rates could potentially rise by approximately 0.8 percentage points above previous forecasts. In its February outlook, the institute had anticipated that the Bank of England would cut rates twice this year from the current level of 3.75% to around 3.25%. The updated analysis, however, suggests that policymakers may be compelled to reverse this course and raise rates back above 4% if inflation driven by energy costs proves to be persistent.
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.”
