UK economy at risk as Middle East crisis drives oil prices up

Bank of England warns Middle East conflict threatens UK financial stability

The Bank of England has warned that the economic shock from the Middle East conflict is intensifying risks to the financial system by threatening to 'crystallise' numerous existing vulnerabilities at the same time.

The warning came as Sir Keir Starmer, UK prime minister, insisted Britain was 'well placed' to weather the Iran crisis, but admitted: 'It is now clear that the impact of this war will affect the future of this country.'

The supply shock from the war in Iran, causing a surge in oil prices and a sell-off in equity and bond markets, is likely to intensify faultlines in the financial system, including tensions in private credit markets, high government debt and stretched valuations, the BoE said on Wednesday.

'The shock will weigh on growth, increase inflation and tighten financial conditions,' the central bank said in the record of last week's meeting of the Financial Policy Committee.

'Adverse impacts on the global macroeconomy increase the likelihood that multiple vulnerabilities could crystallise at the same time, amplifying their effect on financial stability and, ultimately, the provision of vital financial services to UK households and businesses,' it added.

Starmer told a Downing Street press conference that the government was introducing a range of measures to help households, including cutting energy bills from Wednesday.

He also said the government was keeping 'under review' proposals to increase fuel duty from September, and confirmed that new state help for household energy bills was being prepared for the autumn.

Starmer said: 'I want to reassure the British people that no matter how fierce this storm, we are well placed to weather it and we have a long-term plan to emerge from it a stronger and more secure nation.'

However, the BoE's warning underscores how central banks around the world are worried the conflict in the Middle East could cause a prolonged oil supply shock that sends the global economy into a period of stagflation.

Officials at the BoE are worried that the UK is particularly exposed to the fallout from the Iran war because of the country's reliance on imported energy and its exposure to rising government borrowing costs.

'Domestically, the economic outlook has deteriorated, increasing pressure on UK households and businesses,' the central bank said.

Average interest rates on two-year fixed-rate mortgages have risen 0.8 percentage points in the past month. The total number of UK mortgage products has fallen from 8,500 to 7,000.

Based on current overnight rates, the BoE estimated that about half of mortgage customers, or 5.2mn households, could face higher mortgage repayments by the fourth quarter of 2028. But it said the increases would 'remain modest' compared with those in recent years.

The FPC said the UK banking system remained resilient and had 'the capacity to support households and businesses'. But it warned that the recent default of property lender Market Financial Solutions 'highlighted weaknesses in relation to risky credit markets'.

Despite the recent fall in stock markets, valuations remained 'particularly stretched for US technology companies focused on AI', it said, adding that concerns about this sector could intensify given the energy-intensive data centres on which it depends.

The FPC said it had asked regulators to look into increased use of agentic AI by financial services companies, which could bring risks such as increased payment fraud and sharper moves in markets, as well as benefits including higher productivity.

Higher interest rates could 'increase debt-servicing pressures for leveraged borrowers' and put extra strain on struggling private credit funds, which had been hit by falling valuations of loans to software companies threatened by AI and rising requests from investors to get their money back, the BoE said.

Global stocks and bonds last month suffered one of their biggest combined sell-offs since 2022 as the energy shock spooked investors.

Brent crude, the international oil price benchmark, rose 63 per cent in March to close at $118.35 on Tuesday, close to its highest level since the start of the conflict in the Middle East, as traders responded to fears of a prolonged shutdown of the Strait of Hormuz.

The surge has caused severe volatility in global stocks, bonds and other commodities, with Wall Street's blue-chip S&P 500 index falling 5.1 per cent in March even after a strong rally on Tuesday afternoon.

The BoE said the Iran conflict had 'worsened the outlook for sovereign debt globally through its potential to weigh on growth, raise interest rates and increase spending pressures'.

This could 'constrain governments' capacity to respond to future shocks and worsen vulnerabilities in sovereign debt markets', it added.

Hedge funds' heavy use of debt to bet on sovereign bond markets increased these risks, the BoE said.

While hedge funds had reduced the debt they used to bet on UK bond markets since the start of the Iran conflict, cutting their aggregate net gilt repo borrowing by 21 per cent to £74bn in the past month, the central bank said this figure remained 'elevated by historical standards'.