The sharp contrast between the pre-war economic calm and the current turbulence is evident in the Bank of England’s decision to hold rates at 3.75% on Thursday while warning that the Iran war had fundamentally disrupted the UK’s economic outlook. The monetary policy committee voted unanimously to hold, but just weeks ago the same committee had been leaning toward a rate cut in an environment of cooling inflation and modest growth. The US-Israel conflict against Iran has replaced that relative calm with genuine uncertainty and the prospect of rates rising rather than falling.
The pre-war calm was characterised by a relatively clear and benign policy outlook. Inflation was falling, the labour market was softening in a measured way, and financial conditions were gradually easing. Rate cuts were being anticipated, mortgage rates were declining, and consumer confidence was slowly recovering. It was not an exciting economic environment, but it was a manageable and improving one.
Governor Andrew Bailey acknowledged the stark contrast between the pre-war outlook and the current situation. He said the war had introduced a new and unwelcome variable into calculations that had recently appeared relatively clear. His warning about rising petrol prices and potential energy bill increases was delivered with an evident awareness of the disruption the conflict had caused to what had been a gradually improving economic picture.
Financial markets moved decisively away from the pre-war calm. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders priced in a fundamentally changed monetary outlook. The contrast between the pre-war pricing — which had factored in rate cuts — and the post-announcement pricing — which factored in potential hikes — captured the scale of the change the conflict had brought.
For UK households and businesses that had been making financial decisions based on the pre-war calm, the sharp contrast creates real practical challenges. Plans made on the assumption of falling rates may need to be reconsidered. Budgets built on the expectation of declining energy and mortgage costs may need revision. The speed of the transition from calm to turbulence is itself a source of economic cost and financial stress.