The Bank of England has signalled that the prospect of multiple interest rate cuts this year is fading, as the economic shock from the US–Iran conflict pushes up energy prices and revives inflation risks for the UK economy. The shift in tone raises the stakes for households, businesses and markets that had been pricing in a smoother path to lower borrowing costs after a prolonged period of high rates.

Rate-cut hopes under pressure

Before the escalation in the Middle East, Governor Andrew Bailey indicated that market expectations for two UK interest rate cuts this year were "not unreasonable", reinforcing a narrative that the Bank was slowly moving from fighting inflation towards supporting growth. The outbreak of war between the US and Iran has altered that calculus, with higher energy prices and renewed supply disruptions feeding through to inflation forecasts and complicating any decision to loosen policy.

While the Bank of England has not formally ruled out rate reductions, officials now face a more finely balanced trade-off between stabilising prices and preventing a deeper downturn. Businesses that had been banking on lower debt-servicing costs in the second half of the year must reassess investment plans, while households facing elevated mortgage rates see any relief potentially delayed.

Fragile growth and weak confidence

The monetary policy rethink comes against a backdrop of subdued UK growth and deteriorating business sentiment. Recent data show economic expansion remains weak, with higher borrowing costs, lingering inflation and global uncertainty weighing on output. The Institute of Directors’ sentiment index fell sharply in June to minus 61, highlighting the extent to which company leaders are concerned about the outlook for demand, costs and regulation.

Executives report that energy, wage and compliance costs remain stubbornly high, squeezing margins and limiting room for pay rises or new hiring. In this environment, even modest changes in expectations for Bank of England policy can have an outsized impact on investment and hiring decisions, particularly among small and mid-sized enterprises that lack the financial buffers of larger listed companies.

Inflation risks from the US–Iran conflict

The war between the US and Iran has reintroduced a geopolitical risk premium into global energy markets, echoing previous episodes in which tensions around key shipping routes raised the price of oil and gas. For the UK, which remains a significant net importer of energy, higher wholesale prices can filter through to business utility bills, fuel costs and consumer prices, complicating the Bank’s efforts to bring inflation sustainably back to target.

Analysts warn that if energy costs remain elevated for an extended period, the Bank of England could be forced to keep rates higher for longer than markets had anticipated, or even contemplate further tightening if inflation expectations begin to drift upwards. That would risk prolonging the squeeze on indebted households and firms, particularly those with variable-rate loans or upcoming refinancing.

Sector strains: hospitality in the spotlight

The changing rate outlook is especially sensitive for sectors already operating on thin margins, including hospitality, retail and leisure. New figures show that almost a quarter of UK restaurants, pubs and bars are currently running at a loss, underscoring the fragility of a sector that employs hundreds of thousands of people and is central to local high streets. Rising energy costs and borrowing rates compound pressures from wages, business rates and food price volatility.

In response, industry leaders have renewed calls for targeted tax relief to stave off closures and job losses. Under the "VAT’s the problem" campaign, prominent figures such as chef-restaurateur Tom Kerridge are urging the government to cut VAT on hospitality from 20% to 10%, arguing that the current level is unsustainable for many venues. Proponents say a reduced VAT rate would give operators breathing space to invest, hire and absorb higher input costs, while opponents question the fiscal room for such a move given competing demands on the public finances.

Policy makers face a complex balancing act

The Bank of England’s cautious stance highlights the increasingly complex environment confronting UK policy makers. On one side are calls from business groups and sectors under strain for faster relief from high borrowing costs and tax burdens. On the other are the Bank’s statutory obligation to control inflation and the government’s need to maintain fiscal credibility amid elevated debt levels.

Officials must weigh whether maintaining higher interest rates for longer will anchor inflation expectations and protect the currency, or whether it risks deepening a growth slowdown that could erode the tax base and spur higher unemployment. With business confidence already weak, communication from the Bank about its reaction function to new energy and inflation data will be closely scrutinised by markets and corporate treasurers.

Digital verification and structural reforms

Alongside near-term monetary policy concerns, longer-term initiatives are emerging that could reshape the UK’s financial and business infrastructure. The City of London Corporation has proposed a digital identity framework, the Digital Verification Orchestrator, designed to let consumers reuse verified information across financial services and other sectors. Developed with input from EY, Hogan Lovells and the Financial Conduct Authority, the model aims to cut duplication in identity checks, speed up onboarding and reduce fraud.

According to estimates, the framework could unlock more than £5bn for the UK economy over five years, generating about £1.8bn in efficiencies and cutting fraud losses by around £3bn. While still at the proposal stage, such reforms could become increasingly important as policy makers seek ways to raise productivity and competitiveness without large fiscal outlays.

Markets and investors reassess the outlook

Global markets have remained focused on technology and basic resources stocks, with semiconductor firms and miners benefiting from optimism around eventual diplomatic progress and the potential normalisation of shipping routes through key chokepoints. For UK investors, however, the overriding question is how domestic monetary policy will respond if global energy prices stay high.

Portfolio managers are re-evaluating exposure to interest rate-sensitive sectors such as real estate, consumer discretionary and smaller growth companies, while looking for defensive names with strong balance sheets and pricing power. Corporate bond markets are likewise attuned to the possibility that the cost of capital will remain elevated, affecting refinancing decisions and debt issuance.

What comes next

In the coming weeks, attention will focus on incoming inflation and growth data, as well as any further commentary from the Bank of England on how it is interpreting the fallout from the US–Iran conflict. Businesses across the UK will be watching closely, calibrating hiring, investment and pricing strategies to an outlook that now appears more uncertain than it did only a short time ago.

With business confidence already under pressure and key sectors calling for targeted relief, the debate over the timing and scale of UK interest rate cuts will remain central to the broader discussion about how to support growth while keeping inflation in check. The choices made by policy makers in the months ahead will shape the trajectory of the UK economy and the operating environment for companies large and small.