UK inflation rose strongly in March because of higher fuel prices from the Iran crisis. Inflation will dip back towards 2.9% in April. The bigger picture is that inflation will rise close to 4% by the end of the year. Despite this rebound in inflation, the Monetary Policy Committee (MPC) will almost certainly keep interest rates on hold next week − and probably throughout the year − as it balances elevated inflation against a weak labour market, slowing pay growth and a shock to demand as energy prices erode real household incomes.

UK inflation rises as Iran conflict disrupts oil supplies

Inflation jumped to 3.3% in March from 3% in February. This was driven almost entirely by fuel prices, which surged to 4.9% from -4.6% to add 25bps to inflation. The spike in oil prices also saw heating oil inflation swell by 95.3%, adding 8bps to the headline figure.

Airfares were already strong in March due to the early Easter. Inflation in this category rose to 14.5% from 3.8%, which helped to push services inflation up to 4.5% from 4.3% in February. Airfares should drop back in April as seasonal effects unwind, but the impact of this may be smaller than usual because of soaring jet fuel costs. Services inflation more broadly will slow thanks to base effects from last year’s smorgasbord of tax and regulated price increases, so the uptick here won’t bother the MPC too much.

Underlying inflationary pressures remained strong, even as core inflation – which excludes food and energy prices – eased to 3.1% in March from February’s 3.2%. Indeed, we estimate that the MPC’s preferred measure of underlying services inflation, which strips out volatile and regulated prices, held at 4.2%. It’s averaged 4.2% for 18 months now. Even before the conflict in Iran, forward-looking surveys such as the Bank of England’s Decision Maker Panel and PMIs suggested little further disinflation in services.

All told, March’s jump in inflation was a direct result of the conflict in Iran, which sent oil prices surging. Fuel prices will put further upwards pressure on inflation in April, but this will be more than offset by base effects from last year’s swathe of regulated price and tax hikes, as well as new measures from the Autumn Budget to cut energy bills. That will leave inflation at 2.9% next month, although this is still well above our pre-crisis forecast of 2.2%.

UK inflation to rise further, but MPC to stay on hold

Further ahead, inflation will stabilise around 3% until July. That’s when a big increase to the Ofgem energy price cap will prompt inflation to head towards 3.5%. Higher energy prices will also feed into inflation indirectly. For example, surging jet fuel prices will impact airfares throughout the year. Food inflation also seems certain to accelerate given the hit from the big rise in diesel prices for transportation, manufacturing and agriculture and the Middle East’s role in plastic production. This combination of factors means inflation could peak at close to 4% by the end of the year.

However, the weaker labour market will see employees struggle to bid up their nominal wages in response to higher inflation, which they did in 2022. This reduces the risk that energy inflation will bleed into domestically generated price pressures because wages are usually the biggest cost for firms in the services sector. Indeed, there’s a smaller risk of a significant wage-price spiral today compared to 2022. This means the MPC is more likely to keep rates on hold next week and probably throughout the year.

Of course, the risk is that the Strait of Hormuz remains closed for months. Despite the ceasefire, traffic through the Strait is still close to zero. This represents a loss of roughly 13m barrels a day, even after redirection. The longer the Strait remains closed, the more intense supply shortages will become, which would prompt another sharp rise in energy prices. What’s more, the longer energy prices remain elevated, the more likely inflation expectations will become further de-anchored, increasing the likelihood of second-round effects. In this scenario, we think the MPC would be forced to start raising interest rates.

Ultimately, even if there was a swift resolution to the conflict, inflation would remain between 3−3.5% this year as damage to energy infrastructure means prices won’t fall back quickly to pre-war levels. For now, we continue to think the MPC will be able to look through the rise in inflation, especially as inflation would fall rapidly in the second half of 2027 as the impact of higher energy prices fades and weaker real household incomes weigh on growth. That should be enough to keep interest rates on hold this year.

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