In February, the unexpected strong economic growth in the UK is difficult to dispel the gloom of energy shocks. The central bank's monetary policy is caught in a dilemma.

The UK economy maintained rapid expansion in the weeks leading up to the outbreak of the Middle East conflict, indicating to what extent this war has changed the economic prospects of the UK. Data released by the UK Office for National Statistics on Thursday showed that the GDP in February increased by 0.5% compared to the previous month, far exceeding economists' expectations of 0.1% growth, marking the strongest monthly performance since 2024. However, since the end of February when the US and Israel launched attacks on Iran, severe disruptions in energy supply have disrupted the global economic growth outlook. But for the UK, the impact of this war may be more severe than any other major advanced economies. The International Monetary Fund (IMF) lowered growth expectations for major advanced economies on Tuesday, with the UK economy experiencing the largest downward revision, reflecting the inflationary impact of the Middle East conflict imposing a high cost on the UK. The IMF stated that the UK economy is expected to grow by only 0.8% in 2026, much lower than the previous forecast of 1.3%. IMF Chief Economist Pierre-Olivier Gourinchas attributed the downward revision of growth expectations for the UK economy to three main factors: dependence on natural gas imports, lack of energy storage facilities, and the economic slowdown at the end of last year following Chancellor Rives's implementation of a 30 billion tax increase plan. Gourinchas stated that the UK's energy structure is highly dependent on natural gas, and the Middle East conflict has caused the price of natural gas, which the UK heavily relies on, to double. Although much of the natural gas is produced domestically in the UK, a portion still needs to be imported, and imported natural gas, priced at market rates, costs much more. Some experts warn that gas and electricity costs for UK households are expected to rise by nearly 20% this summer, pushing the average bill in July close to 2,000. The IMF also warned that the risk of a "substantial" increase in food prices in the UK is growing due to a shortage of fertilizers impacting farmers before the critical spring planting season. With the rise in gas, electricity bills, and food prices, it is expected that inflation in the UK will reach close to 4% this year. This may force the Bank of England to maintain interest rates unchanged for the remainder of the year, or even raise rates to contain inflation. In addition to the IMF lowering growth expectations for the UK economy, recent data has also revealed the dim outlook for UK economic growth. The UK's S&P Global Purchasing Managers' Index (PMI) fell to a six-month low of 50.3 in March, significantly down from the previous 53.7 and well below the earlier estimate of 51 - although the index remains above the 50 boom-bust line, theoretically representing economic expansion, it has already signaled a slowdown. Furthermore, a quarterly survey of chief financial officers in the UK by one of the world's four major international accounting firms, Deloitte, showed a sharp decline in the net optimism index from -13% at the end of 2025 to -57%, reaching the lowest reading since the first quarter of 2020 when the COVID-19 outbreak occurred. At the same time, UK businesses' expectations for inflation a year ahead have risen to 3.6%, hitting the highest level since the third quarter of 2023. It is understood that Rives previously regarded Deloitte's quarterly survey of chief financial officers as an important indicator of UK business sentiment. Deloitte stated that with the significant increase in global energy prices caused by the deteriorating geopolitical situation in the Middle East, signs of global economic stagnation are becoming increasingly apparent as global businesses rapidly shift to a cost-cutting mode, with the cost being a reduction in hiring, discretionary spending, and long-term investment planning for businesses. Deloitte also added that the survey showed 61% of chief financial officers were very concerned about the rise in energy prices and inflation, and even the potential "stagflation" leading to a rise in interest rates. Ian Stewart, Chief Economist at Deloitte in the UK, said: "In the past 16 years, UK chief financial officers have rarely been as focused on cost control and conservative cash preservation measures as they are today." Deloitte found that 79% of chief financial officers surveyed expect a significant decrease in hiring in the next 12 months, the highest level since the second quarter of 2020 and significantly higher than 55% at the end of last year. Energy shock exacerbates risks of stagnation, Bank of England caught in a dilemma The energy shock caused by the Middle East conflict is not only dragging down the UK economic recovery but also exacerbating the risks of upward inflation in the UK. This means the UK may face the grim prospect of stagflation, which will put the Bank of England in a dilemma of whether to stabilize growth or curb inflation. In a unanimous decision of 9:0 last month, the Monetary Policy Committee of the Bank of England decided to keep the benchmark interest rate unchanged at 3.75%. This is the first time in four and a half years that the committee has united in its policy views, with the fluctuation of energy prices and the risks of upward inflation caused by the Middle East conflict being the core considerations for the central bank to postpone its loose policy. The Bank of England stated in its decision that the Middle East conflict has led to a significant increase in global energy and commodity prices, not only directly pushing up household fuel and utility expenses in the UK but also indirectly transmitting through the channel of corporate costs, resulting in a short-term increase in the consumer price index (CPI). The Bank of England is also highly vigilant about the "secondary transmission effects" in the wage and price-setting process, worrying that the rise in energy prices will trigger a spiral of wage and price increases, exacerbating domestic inflation pressure. This decision marks a significant shift in the monetary policy stance of the Bank of England. The Bank of England removed the statement from the decision in February about the possibility of further interest rate cuts. The "dovish" members of the committee, who have consistently advocated for loose policies, also stated that if energy supplies are subject to prolonged shocks, rate hikes will become a necessary choice. Bank of England Governor Bailey emphasized that monetary policy must address the more persistent risks of UK inflation, and regardless of changes in geopolitical situations, the central bank's core responsibility is to ensure that inflation returns to the 2% target level. Megan Greene, a "hawkish" policy maker at the Bank of England, recently stated that the threat of a resurgence in inflation is "paramount," warning that significant wage and price increases may occur. Greene implied that the threat of "second-round effects" of inflation would weigh more heavily in her considerations ahead of the next rate decision on April 30 by the Bank of England Monetary Policy Committee. The Bank of England stated that current monetary policy must balance the risks of persistent inflation with downward economic pressures. Faced with the inflation risks posed by geopolitical conflicts, the Bank of England chooses a "safety-first" strategy. Analysts in the industry believe that in the short term, the expected monetary easing cycle in the UK market may be difficult to start, and subsequent policy adjustments will depend heavily on the evolution of the Middle East situation and energy price trends. However, with recent signs of easing tensions in the Middle East, market expectations for the Bank of England to tighten monetary policy have cooled. Bruna Skarica, Chief Economist at Morgan Stanley in the UK, stated in a report that the Bank of England may keep interest rates unchanged at 3.75% in the coming months, rather than raising them. Skarica said that the Middle East conflict has increased the UK's inflation risk, but a weak job market may limit inflation growth. She said that if global energy supplies return to normal levels, the Bank of England may signal a rate cut as early as the fourth quarter of 2026. Callum Picklin, Senior Economist at Peel Hunt, also stated that while there are concerns about inflation, the likelihood of the Bank of England raising rates in 2026 has decreased. He pointed out that the market's previous expectations for the Bank of England to start a rate hike cycle in 2026 are facing a logical correction, with the direction of the Middle East conflict substantially replacing domestic economic data as the determining variable in the short-term interest rate path. Data from the London Stock Exchange Group shows that investors have fully priced in the possibility of a 25 basis point rate hike from the Bank of England in 2026, with a 40% chance of a second rate hike by the end of the year. However, Peel Hunt's analysis suggests that this linear tightening bet overly relies on the assumption that the pricing logic heavily discounts the ongoing geopolitical risk of the Middle East conflict. The institution's base expectation is that if the Middle East conflict is expected to calm down quickly, the Strait of Hormuz will return to navigation, and the external shocks of energy prices are likely to recede. Once the situation calms down, the pricing logic will quickly switch from "preventing runaway inflation" to "rescuing the economic slump," giving the Bank of England room to maneuver for a rate cut within the year. However, Picklin also added that if the Middle East conflict continues, the Bank of England may be forced to take aggressive action to boost confidence and stabilize inflation expectations. Bansi Madavani, an economist at ANZ Bank, stated that the Middle East conflict and the resulting rise in energy prices have created stagflation shocks to the UK economy, with overall inflation expected to rise to over 3.0% year-on-year in the next few months, while the annual growth rate may be below 1.0%. She added that the continued shocks from energy price increases will increase the likelihood of an economic recession, so the Bank of England may not raise rates to address the initial impact of rising energy prices but instead take a wait-and-see approach.