We expect Monetary Policy Committee (MPC) members to hold UK interest rates at 3.75% when they meet on the 19 March 2026. Normally, we’d expect the Bank of England (BoE) to look through an energy price shock. However, given inflation has been above target for five years and inflation expectations are still elevated, it probably doesn’t have that luxury. If energy prices and, crucially, futures curves stay around current levels, then we think interest rates will be on hold for the rest of this year before falling in 2027. The weak labour market means the chance of second-round effects is much lower now than in 2022. This raises the bar to rate hikes in response to an energy shock. All things being equal, it would take a bigger rise in energy prices with inflation rising towards 5% for the MPC to consider hiking rates.

UK energy prices, inflation and interest rates – what next?

An energy shock is every central banker’s worst nightmare. The simultaneous increase in prices and contraction in demand is a toxic supply-side mix policymakers are ill-equipped to deal with. After all, the BoE can print money, but it can’t print oil. The BoE’s goal now will be to minimise the shock’s second-round effects. This means trading off the downward impact on demand against the risk of firms passing on cost increases and employees trying to protect their real wages.

Reflecting the scale of volatility we’re all coming to terms with, it was only two weeks ago that a March rate cut looked like a dead cert. A cut clearly makes no sense now. Given uncertainty about the outlooks for energy prices, inflation and the economy, the most sensible thing for the BoE to do is wait for more clarity. This rules out a rate cut next week and probably one in April too, unless there’s a rapid resolution to the crisis.

The path further ahead is currently as clear as crude. It depends entirely on how energy prices develop through the next few months and quarters. Admittedly, the sharp increases in both oil and especially natural gas prices are nowhere near as large as the 2022 shock. However, they’re still around 50% higher than the assumptions underpinning February’s MPC report.

Higher oil prices will feed through into fuel prices reasonably quickly. So, we’re likely to see petrol prices jump from around £1.33 a litre the week before the escalation to close to £1.60 a litre in the next few weeks. This will probably add about 0.5ppts to inflation in April, but it won’t be enough to stop the big fall expected here because base and regulated price effects come into play. The oil price impact will mean inflation drops only to around 2.5%, rather than the 2% forecast.

Household utility bills are more complicated. However, based on the current futures curves, which show the price of commodities contracts across different dates and therefore market expectations for future prices, these could rise by 25% or more by the end of the year. Taken together, it means inflation would finish the year between 3.5−4%. There’s a significant risk too of an even bigger move higher. Energy-futures curves imply the markets expect a relatively swift resolution to the conflict. Evidence of prolonged disruption could see them move sharply higher.

How could the BoE respond to the energy price shock?

The textbook response to these energy-price movements is for the BoE to ‘look through’ the shock because their impact on inflation would only last a year. Meanwhile, it takes 2−3 years for interest-rate changes to fully impact the economy. Instead, the BoE would usually be expected to focus on the negative impact on demand.

However, inflation has been above the 2% target now for almost five years and inflation expectations are still above normal levels. This means the BoE may not feel it has the luxury of looking through another energy price shock, especially as household inflation expectations are sensitive to food and energy prices. Indeed, the BoE was heavily criticised for being slow to raise interest rates during the Russia-Ukraine crisis. That means the MPC will be more sensitive to higher inflation now, even if it is being driven by a temporary surge in energy prices.

A UK interest rate cut as likely as a hike?

However, this doesn’t necessarily mean rate hikes are on the cards. The UK economy is in a radically different state to 2022 and the risk of second-round effects is much smaller now than it was then. The labour market is much weaker now, with the UK unemployment rate at 5.2% compared to 3.8% in 2022. Private sector wage growth has also slowed sharply. This will make it harder for employees to protect real pay. We know that labour market weakness has been a focus of concern for at least four MPC members. An energy price shock is only likely to make the employment outlook worse.

What’s more, monetary policy is much tighter now. Interest rates at 3.75% are still probably in restrictive territory compared to just 0.5% in 2022. This means the BoE can afford to wait rather than having to raise rates to create restrictiveness. Fiscal policy will also probably be less accommodating now than in 2022, when the government offered a support package worth around £80bn. In theory, the Chancellor could offer one-off support to businesses and households with only a minor impact on fiscal headroom in three years’ time. But, this would risk higher gilt yields and the possibility of having to raise taxes again later this parliament, which is a risk Rachel Reeves might not be willing to take.

These two factors – the weaker labour market and interest rates in more restrictive territory – mean the bar to rate hikes is high. We suspect we’d need to see evidence of second-round effects before an MPC majority would consider raising interest rates. Given the risk of second-round effects becomes greater the higher energy prices go − and the longer they stay there for – we’d probably have to see energy prices stay high through the end of the year for this to be a risk.

The upshot is that the most sensible and likely policy response for the BoE is to keep rates on hold until there’s more clarity on energy prices this year, all the while watching for emerging evidence of second-round effects, either to the upside or the downside.

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