The Bank of England is increasingly likely to keep interest rates on hold after easing oil prices reduced concerns that the conflict in Iran would trigger a prolonged inflation shock, according to Capital Economics.
The consultancy said the recent decline in crude oil prices could mark a turning point for the UK economy, although it warned that households are still likely to face a difficult period as higher energy costs and inflation continue to feed through.
Ashley Webb, Senior UK Economist at Capital Economics, said petrol prices and mortgage rates remain well above levels seen before the outbreak of the Iran conflict, but suggested the worst of the upward pressure may now have passed.
He forecasts UK inflation will climb to around 4% in early 2027 and expects the economy to stagnate for six months during the second and third quarters of 2026.
Webb added that falling oil prices have significantly reduced expectations of further monetary tightening, with financial markets now pricing in just a 5% probability of a 25-basis-point rate increase at the Bank of England’s next policy meeting.
Investors have also lowered their expectations for peak interest rates, with forecasts falling from a range of 4.25%-4.50% last week to around 4.00%-4.25% currently.
The shift reinforces Capital Economics’ view that the Bank of England will maintain Bank Rate at 3.75%, with the risks of further rate hikes continuing to diminish as energy market pressures ease.
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