The forecasts that underpin both the Treasury’s fiscal plans and the Bank of England’s monetary strategy have been rewritten by the Iran war, as the Bank voted unanimously to hold rates at 3.75% on Thursday and warned that the conflict’s energy price impact had materially changed the UK’s economic outlook. The monetary policy committee described the war as a significant new shock that had pushed inflation projections higher and replaced anticipated rate cuts with potential hikes. For Chancellor Reeves and Governor Bailey, the rewriting of their forecasts creates challenges in different but related ways.
For the Bank, the forecast rewrite means abandoning assumptions about a steady return to the 2% inflation target. The institution now projects inflation rising toward 3.5% in March and remaining elevated throughout 2026, requiring a fundamental reassessment of the rate path it had been planning. The shift from a cutting to a potential hiking orientation represents one of the most significant forecast revisions in recent memory.
For the Treasury, the rewritten forecasts create fiscal challenges. Higher inflation means higher debt servicing costs in real terms for inflation-linked gilts. Rising gilt yields mean higher nominal borrowing costs. And a potential rate hiking cycle could dampen the economic growth that underpins the tax revenue assumptions in the government’s fiscal plans. The Treasury’s carefully constructed fiscal envelope is under pressure from multiple directions.
Governor Bailey acknowledged the challenging environment for both institutions. He warned of rising energy costs and said the Bank was prepared to act if inflation threatened to become entrenched. His implicit acknowledgement of the forecast disruption was framed in terms of the Bank’s commitment to its mandate rather than the political or fiscal consequences.
Financial markets moved to reflect the rewritten forecasts. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders priced in the possibility of rate hikes before year end. The magnitude of the forecast revision underscores the Iran war’s status as a genuinely significant event for UK economic planning.