Interest rates ‘could rise back above 4%’ to deal with inflation shock

The Bank of England could raise interest rates back above 4 per cent if soaring energy prices lead to a fresh inflation shock, according to a new report.

The National Institute of Economic and Social Research (NIESR) warned borrowing costs could be driven higher as war in the Middle East pushes up the price oil and gas.

That would be a bruising setback for millions of families pinning their hopes on cheaper mortgages.

The Bank has cut rates six times since August 2024 – bringing them down from 5.25 per cent to 3.75 per cent – and it was hoped further rate cuts would follow this spring.

But the chances of such a move have been severely dented by surging energy prices the US-Israel war with Iran spreads through the region.

According to bets on financial markets, there is now just a one-in-five chance the Bank of England will cut rates again this month, down from around four-in-five last week.

And NIESR said the next move in interest rates may in fact be up.

The group said a ‘persistent shock to energy prices may force the Bank of England to raise rates back above 4 per cent’.

NIESR economist Ed Cornforth said: ‘The conflict in the Middle East will have material implications for the economic outlook.

‘The Bank of England will have to contend with a shock to global energy prices, with the question of persistence hanging over their heads.

‘This will cause problems for Rachel Reeves as financing costs increase, putting further pressure on an already precarious fiscal outlook.’

The surge in energy prices has revived memories of runaway inflation seen after Russia’s invasion of Ukraine in 2022.

That sent inflation in the UK up to 11.1 per cent – and forced the Bank of England to raise rates sharply to 5.25 per cent.

It was hoped inflation was finally coming back under control, paving the way for further rate cuts.

But the war in the Middle East has cast a major shadow over the outlook and fuelled fears of a new inflation shock.

That will put the Bank of England and its governor Andrew Bailey on high alert.

Mortgage lenders have already started ditching plans to cut the price of home loans.

Borrowing and savings specialists Moneyfacts said ‘several lenders have pushed pause on planned rate cuts’ – dashing the hopes of millions of families hunting for cheaper home loans.

It said the moves have come ‘in response to the conflict in the Middle East and its potential economic repercussions’.