Energy shock expected to delay Bank of England rate cuts and weigh on real incomes
Oxford Economics expects the latest flare-up in the Middle East to push UK inflation higher this year and to complicate the path for interest rate cuts, with implications for borrowing costs across the mortgage market.
The consultancy estimates that the disruption to energy markets will add about 0.4 percentage points to UK inflation in 2026. Consumer price growth is now projected to average around 2.7% this year, compared with a pre‑conflict forecast of 2.3%, keeping inflation above the Bank of England’s 2% target for longer. Higher oil prices, a weaker pound and a temporary jump in wholesale gas prices underpin the revised outlook.
Oxford Economics assumes that interruptions to shipping through the Strait of Hormuz last for up to two months. On that basis, Brent crude is expected to average just under $80 a barrel in the second quarter, around $15 higher than in its previous February forecast, before easing back towards a little over $60 by the end of the year. European gas prices are assumed to be roughly 30% higher on average in the second quarter than in the earlier forecast, with prices normalising thereafter.
The impact on UK households will come mainly through regulated energy bills and forecourt prices. Because Ofgem adjusts the domestic price cap quarterly and with a lag, the rise in wholesale gas prices would not feed through until July. Oxford Economics calculates that the typical household energy bill could rise by about 13.5% at that point, adding around 0.5 percentage points to CPI inflation in that month. Petrol prices are expected to reflect higher crude costs more quickly, though fuel duties will blunt part of the increase in headline inflation.
“Higher oil prices will quickly feed through to petrol prices, while a rise in European gas prices will see a sharp increase in household energy bills in July,” said Edward Allenby (pictured right), senior UK economist at Oxford Economics. “We will nudge down our below-consensus GDP growth for 2026, as the weaker picture for real incomes weighs on consumer spending.”
Under the revised projections, UK GDP growth for 2026 is trimmed to 0.8%, with real household incomes expected to stagnate. While the firm still sees output expanding by 1.3% in 2027, the near‑term environment is one of subdued growth, higher‑than‑target inflation and a degree of economic slack.
For monetary policy, the shock arrives just as markets had been positioning for an imminent easing cycle. Before the conflict escalated, market pricing suggested there was an 81% probability of a Bank Rate cut in March. By the end of this week, that implied probability had fallen to around 24%, with the chance of an April move reduced to about 61%. Oxford Economics judges that the increased uncertainty around the inflation outlook makes a March cut unlikely.
“If the conflict is short and energy prices quickly fall back, the Monetary Policy Committee will probably resume cutting in either April or June,” Allenby said. “But if the surge in energy prices persists or expands, the MPC will be set for an extended pause.”
The firm’s baseline still assumes that Bank Rate will be reduced later this year, but at a slower pace than previously expected. The policy rate is now projected to stand at about 3.75% at the end of 2026, down from 3.75% at the end of 2025 but higher than might otherwise have been the case without the energy shock. Ten‑year gilt yields are forecast to edge lower only gradually, remaining above 4% for much of the forecast horizon.
For mortgage professionals, the combination of stickier inflation and a delayed start to rate cuts suggests that funding costs may stay elevated for longer. Swap rates and gilt yields, which underpin fixed‑rate mortgage pricing, are likely to remain sensitive to incoming data on inflation and energy markets, as well as to any further shifts in expectations for the Bank of England’s policy path.
Oxford Economics also highlights the broader fiscal backdrop. The Office for Budget Responsibility’s Spring projections, published before the latest energy shock, already relied on relatively optimistic assumptions for growth and migration. Further downward revisions to population and output growth could leave the public finances on a weaker footing than headline figures imply, limiting scope for fiscal support should the economy slow more sharply.
In the months ahead, attention in the mortgage market is expected to focus on how quickly energy prices settle, how the MPC responds to the changing backdrop, and whether real incomes start to recover. Until the picture becomes clearer, volatility in rate expectations is likely to remain a feature for lenders, intermediaries and borrowers alike.
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