The Bank of England is now expected to raise interest rates rather than cut them several times this year as the surge in oil prices triggered by the US-Israeli war with Iran threatens to propel inflation to almost 4 per cent.

Investors have priced in about a 70 per cent chance of the Bank of England increasing rates by a quarter point before the end of the year. Just two weeks ago they expected two quarter-point cuts in 2026, with the first coming at the central bank’s meeting next Thursday.

UK government bonds have suffered the heaviest selling since Liz Truss’s disastrous mini-budget in 2022. Over the last week, the yield on the benchmark ten-year UK government bond has jumped by around 0.4 percentage points to 4.74 per cent, by far the largest rise in borrowing costs within the group of rich economies. 

On Monday alone, yields rose by 0.14 percentage points. The yield on the two-year jumped by as much as 0.25 percentage points.

The drastic recalibration of market rate expectations has been driven by oil prices skyrocketing over the past week amid little sign of and end to hostilities between the US, Israel and Iran.

The cost of a barrel of Brent crude, the international benchmark, rose by nearly 30 per cent on Monday to just under $120. WTI, another international benchmark, registered its largest weekly record gain last week amid fears that the continued closure of the Strait of Hormuz, a key shipping artery in the Gulf, will rock the oil market for some time.

Gas prices have also surged, to which the UK is uniquely vulnerable because it imports large quantities to heat homes.

Industry observers have also warned that global food prices are likely to shoot up if fertiliser supplies are not able to pass through the Strait of Hormuz soon.

Analysts at Deutsche Bank predicted that UK inflation would rise to nearly 4 per cent by the end of the year, double the Bank of England’s target, if there was no swift conclusion to the war in the Middle East and energy prices remained high. There have been predictions that the energy price cap will increase by £500 in the summer.

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Just a handful of days ago, the market thought there was a 90 per cent chance of the Bank of England lowering rates by 0.25 percentage points at the next meeting of its monetary policy committee on March 19. Further reductions were also expected, with some analysts predicting that rates would fall to 3 per cent from 3.75 per cent before the end of the year.

Next week the European Central Bank and US Federal Reserve will announce their latest interest rate decisions. Speeches by Christine Lagarde, the ECB president, and Jerome Powell, chairman of the Fed, will detail their assessments on how they think the Iranian oil shock will affect their respective economies and how central bank policy might respond. 

Dario Perkins, head of global macro at TS Lombard, said: “Inflation is already overshooting targets and — in their minds — that makes expectations ‘more fragile’. For now, all rates cuts have been postponed.”

Traders are pricing in a rate rise by the ECB before the end of the year because the European economy is heavily exposed to the higher cost of energy imports. America is more insulated because of its large domestic shale industry, but pump prices have already reached their highest level since summer 2024.

In response to the increased likelihood of the Bank of England lifting rates, high street lenders have raised mortgage rates because they base the financial structure of their home loans on investors’ outlook for central bank policy. Last week Nationwide, Britain’s biggest building society, lifted rates on some of its products by a quarter point. HSBC and Coventry Building Society said they would do so too.