Bank of England under pressure as inflation could rise 'back above 5 per cent' after oil price soars

Traders in money markets now believe there is up to a 75 per cent chance that policymakers could raise borrowing costs back to four per cent before the end of 2026.

The dramatic shift in expectations followed Brent crude surging by nearly 30 per cent overnight to almost $120 per barrel, its highest level since 2022.

Just days ago, before US and Israeli military action against Iran, traders had assigned an 80 per cent likelihood to a rate cut at the Bank's next meeting.

George Cole, an economist at Goldman Sachs, said interest rate rises "are possible under scenarios of much higher commodity prices".

Economists warned that UK inflation could surge back above five per cent if elevated energy prices persist, more than doubling the Bank's two per cent target.

RSM UK economist Tom Pugh said the latest spike in oil and gas prices meant the UK "is looking at inflation back above five per cent."

The doubling of natural gas prices alone would contribute three percentage points to inflation, with oil adding at least another half a percentage point, according to his analysis.

ING economist James Smith calculated that price growth would reach 4.7 per cent by September should the oil surge continue through the second quarter.

The potential inflation rebound represents a significant setback for the Bank, which had anticipated hitting its target this spring before the conflict erupted.

Chancellor Rachel Reeves is maintaining daily contact with Bank of England Governor Andrew Bailey as the government monitors the unfolding energy crisis.

Prime Minister Sir Keir Starmer confirmed the close coordination on Monday, stating that ministers are working across departments and with international partners to mitigate the economic fallout.

"The job of government is obviously to get ahead, to look around the corner, to work with others," Mr Starmer said.

The Chancellor will participate in discussions with G7 finance ministers later today regarding the potential release of global oil reserves to alleviate the supply shock.

The escalation of hostilities and ongoing disruption to shipping through the Strait of Hormuz, which handles roughly a fifth of global crude oil flows, has alarmed both the City and Whitehall.

Five-year swap rates, a crucial benchmark for mortgage pricing, climbed above 4 per cent on Monday for the first time in twelve months.

The average interest rate on two-year fixed mortgage deals has already crept up from 4.82 per cent to 4.87 per cent within the past week.

Matt Cairns, head of fixed income strategy at Rabobank, said the "pivotal question is how deep and prolonged" the Middle East conflict becomes.

"Even with the global economy's lower sensitivity to energy shocks and more diversified gas sourcing, a sustained rise in prices would still act as a tax on consumers and corporates," he added.

Mr Smith noted that the duration of elevated prices matters more than peak levels, given the UK's household energy price cap averages wholesale costs over three months.