An emerging framework for peace between the United States and Iran has handed the Bank of England a clear opportunity to hold interest rates steady when its Monetary Policy Committee meets this Thursday, just a week after the European Central Bank raised borrowing costs for the first time in nearly three years. The agreement, which includes the reopening of the Strait of Hormuz, is expected to ease the surge in energy prices that forced Threadneedle Street to abandon earlier plans to cut rates.
Monetary Policy Outlook
The Bank’s MPC will announce its decision on 18 June, with the base rate widely expected to remain at 3.75 per cent, where it has stood since December 2025. The path towards that hold was sharply altered by the Iran conflict. In February, markets were pricing in one or two rate cuts this year; the war’s eruption sent oil prices soaring, driving up energy costs and stoking inflation, forcing the MPC to reverse course. Governor Andrew Bailey has signalled little urgency to raise rates, noting that “we have already tightened policy considerably in response to the shock relative to what had been expected by markets” and that this is already affecting the economy. He has suggested it is appropriate to look through temporary inflation overshoots given the weakness in the real economy, adding that tighter financial conditions provide the committee with time to respond.
The MPC’s last meeting in April revealed a growing hawkish streak. The committee voted 8-1 to hold at 3.75 per cent, but one member voted for a 25 basis point increase to 4 per cent, citing concerns over the Middle East conflict’s impact on inflation. That dissent marked a shift from the unanimous 9-0 hold in March. Since then, domestic economic data has weakened: April’s monthly GDP figures showed a contraction, surveys point to renewed weakness in May, and the unemployment rate in March was higher than anticipated, with further hiring weakness indicated by business surveys. Meanwhile, April’s headline CPI inflation fell to 2.8 per cent, though the Bank has warned it could rise again later in the year because of energy risks. Kathleen Brooks, research director at XTB, noted that even though producer prices and headline inflation are rising sharply, “this is not feeding into core inflation . . . or higher wages”, suggesting pass-through effects are weaker than originally assumed. Goldman Sachs expects the MPC to remain on hold through 2026, with cuts possible only in 2027.
The European Central Bank’s decision on 11 June to raise its key rates by 25 basis points – the deposit facility rate to 2.25 per cent, main refinancing operations to 2.40 per cent and the marginal lending facility to 2.65 per cent – came after a long period of steady policy. The ECB explicitly cited “inflation pressures” generated by the war in the Middle East as a reason for the increase, revising its inflation outlook upwards to an average headline rate of 3.0 per cent for 2026. The ECB stressed it is not pre-committing to a particular rate path and will remain data-dependent.
Market Reactions
The news of a potential peace deal triggered an immediate response in financial markets on Monday morning. Brent crude oil fell almost 5 per cent to $83 a barrel, reflecting expectations of increased supply once the Strait of Hormuz – a critical chokepoint for global oil and commodity transport – reopens. The price of UK government bonds also fell, with the 10-year gilt yield dropping more than 1 per cent to its lowest level since mid-April. That decline, along with a 1.5 per cent fall in two-year gilt yields, signals that money markets are removing some of their expectations for an interest rate hike in 2026. The 10-year gilt yield was trading at 4.80 per cent on 15 June. Lower gilt yields reduce government borrowing costs but also indicate a reduced perceived risk of further tightening.
Impact on Households and Borrowers
For British consumers, the most immediate consequence of a rate hold and falling bond yields may be felt in mortgage pricing. Swap rates – the wholesale markets from which mortgage lenders price their deals – could fall further, though the industry remains cautious. According to Moneyfacts, the average two-year fixed residential mortgage stood at 5.61 per cent, having risen from 4.84 per cent on 28 February, before the conflict began, to a high of 5.9 per cent by early April. By 1 June, that average had edged slightly higher to 5.68 per cent, while the average five-year fixed rate was 5.62 per cent. Two-year tracker deals, favoured by many homeowners renewing this year, remain lower at 4.49 per cent.
Adam French, head of consumer finance at Moneyfactscompare.co.uk, said mortgage borrowers would “breathe a sigh of relief at the news of a peace deal in Iran”. He added: “While we are far from being out of the woods yet, a lasting peace deal should dramatically reduce the risk of the Bank of England’s worst-case scenario for inflation and interest rates becoming a reality.” French urged caution, noting that inflation and economic data will continue to influence the outlook, but said a lasting peace “should remove one of the biggest risks to mortgage costs and may help restore a more stable environment for hard-pressed remortgage borrowers and prospective buyers.”
Jamie Elvin, director at Strive Mortgages, emphasised a message of “slowly but surely” rather than immediate benefits. “We could see some lenders become more competitive on fixed rate pricing in the coming weeks, but borrowers shouldn’t expect a dramatic overnight shift,” he said. “While this removes one source of uncertainty, the direction of UK mortgage rates will still be driven largely by inflation, swap rates and Bank of England policy. It’s encouraging for the housing market, but it’s not a silver bullet.”
There has been a notable shift in borrower preference towards shorter-term fixes, with demand for two-year deals rising even though five-year rates are currently lower, suggesting homeowners are betting on future rate decreases and willing to pay a slight premium for flexibility. The wider housing market remains under strain: Rightmove reported a 0.6 per cent decline in the average price of property coming to market in June 2026, the largest June fall in 14 years, as sellers adjusted expectations. Annual house price growth is modest, with forecasts from Savills and Knight Frank revised downwards, and regional variations persist – prices are rising faster in more affordable northern markets, Scotland and Wales (2 to 3.6 per cent), while London and the South are seeing flat or slightly falling values.
On food and fuel, the damage from higher energy costs may already be locked in for many consumers. Oil has already been more expensive, so energy costs will need to factor that in – feeding through to the cost of producing food, manufacturing products and powering buildings or vehicles. Petrol prices could eventually come down, but the energy price cap has already been set for July to September. The RAC said last week that its analysis suggested prices should keep falling: “Unleaded ought to come down by another 4p at least while diesel should drop even further, by possibly as much as 8p.”
Heating oil, which reacts more quickly to wholesale prices, has already seen a dip: the average price for homeowners to buy it on Monday was 79.4 pence per litre, down from above 81p on Friday last week and significantly below the over 133p within the first weeks of the war. Before the conflict, it was around 60p. Food costs increase gradually over time as different pricing factors impact supply, but the hope is that oil not spending too long above $100 might mean the worst of food price inflation is avoided over the long term. However, prices have already gone up and do not tend to go back down even if inflation slows – reversing would require deflation. Beyond energy, fertiliser costs, disrupted supply lines, packaging taxes and rising employment costs all affect the eventual price of products. The Food and Drink Federation has revised its food inflation forecast upwards, expecting it to reach 9 to 10 per cent by December 2026. Chocolate has seen dramatic price increases – 16 per cent in the past year, 43 per cent since 2022 – driven by soaring global cocoa prices exacerbated by dry weather in West Africa and disease affecting cocoa trees, while climate-related extreme weather events are increasingly impacting beef and butter prices.
