Why economists think interest rates WON'T rise this year - despite markets forecasting four hikes after Iran chaos

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Traders are now betting on four interest hikes this year, which would see the Bank of England base rate rise from 3.75 per cent today to 4.75 per cent by Christmas.

This is because policymakers want to minimise the inflationary threat posed by soaring oil and gas prices, as a result of the conflict in the Middle East. 

Prior to the war, markets were betting on two interest rate cuts to 3.25 per cent. At present, they are fully pricing in three 25bps hikes to 4.5 per cent, and a 50 per cent chance of another to 4.75 per cent.

Last week, the Bank of England held interest rates at 3.75 per cent. Its next decision is on 30 April, with five further meetings scheduled for the remainder of 2026.

Traders currently think there is an 85 per cent chance of a rate hike at the Bank of England’s next meeting.

Were interest rates to rise to 4.75 per cent, as traders are currently betting, then this would see fixed rate mortgages continue to rise. The lowest rates have gone from around 3.5 per cent to above 4 per cent since the conflict began.

However, a number of economists believe markets have overreacted to the war, the inflation threat and its potential ramifications for interest rates. 

Economists at Barclays, Capital Economics and Oxford Economics have all told This is Money that they expect interest rates to remain at 3.75 per cent into next year.

They all think that the inflation spike caused by the war won't be as big or long lasting as what happened throughout 2022 and 2023.

They also believe that policy makers at the Bank of England will be equally concerned by low economic growth and rising unemployment - the two major risks if interest rates are put up again - as they will with inflation. 

Economists at Oxford Economics expect Consumer Price Index inflation to peak at 4.1 per cent in the second half of this year, making for an average of 3.6 per cent over 2026 as a whole. The figure was 3 per cent in the 12 months to January.

They then think these increases should unwind over the course of 2027, with inflation dropping below the Bank of England's 2 per cent target in the second half of next year.

While an energy price spike and inflation fears is what's prompting traders to bet on hikes, Edward Allenby, senior economist at Oxford Economics says it will also be keeping a careful eye on the health of the economy.

Cautious: Last week, the Bank of England held interest rates at 3.75%. Its next decision is on 30 April, with five further meetings scheduled for the remainder of 2026

'Before the outbreak of the war, most of the [Bank's Monetary Policy] committee had a bias to loosen policy further, due to the weak outlook for the economy and the fragile labour market. Neither of these worries have dissipated,' he says. 

'So if the conflict proves short-lived and oil and gas prices drop back quickly, the dovish majority could return to their original position later this year.'

Allenby thinks financial markets interpreted the Monetary Policy Committee's (MPC) messaging 'very hawkishly' - in other words, markets think the MPC will prioritise low inflation over economic growth.

'While we agree that a rate hike this year is certainly possible, depending on the duration of the war in the Middle East, it's not our central forecast,' adds Allenby. 

'Indeed, in an interview with the BBC after the interest rate announcement, Governor Andrew Bailey suggested that markets were "getting ahead" of themselves in assuming multiple rate rises. 

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'Bailey's comments were clearly more dovish than the minutes, suggesting he felt the initial message had been misinterpreted.'

Allenby, for now, is confident that the economy will be a key concern for the central bank this year and therefore thinks the MPC will hold interest rates at 3.75 per cent into next year.

'The economy's starting position is very different to the 2022-2023 episode. There is far more slack in the economy, which limits firms' pricing power and workers' bargaining power in wage negotiations,' he says. 

'The committee also feels that the current policy rate is already "somewhat restrictive", while there is much less scope for expansionary fiscal policy to support activity in the same way as it did at the time of the previous energy shock.

'As a result, if our oil and gas price assumptions are in the right ballpark, we think the most likely outcome is that the MPC keeps bank rate at its current level for the rest of this year and well into 2027.'

Jack Meaning, UK chief economist at Barclays also thinks that the Bank will keep base rate at its current level for the rest of the year, and that this will be enough to see any likely inflation spike drop off.

'We expect bank rate to stay at 3.75 per cent for the rest of this year,' says Meaning.

'We assess that keeping policy this restrictive for an extended period is sufficient to bring headline CPI back to 2 per cent in two years' time, consistent with the Bank of England's mandated target.'  

Paul Dales, chief economist at Capital Economics also thinks that interest rates will be held at 3.75 per cent into next year.

He thinks that traders pricing in three or four rate hikes does not factor in the poor outlook for jobs. 

'The economic backdrop is much less conducive to a prolonged period of high  inflation than in 2022,' says Dales. 'GDP growth is lower, the labour market is weaker , fiscal support will be smaller and interest rates are at a higher level.'

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'After the 2022 energy price shock, the unemployment rate initially fell to 3.6 per cent before rising to 4.3 per cent. The unemployment rate now is 5.2 per cent, and with higher energy prices building on last year's rises in firms’ labour costs, it may rise to 5.6 per cent or even 6.2 per cent in an adverse scenario.

'It feels as though market pricing is putting too much emphasis on the inflation risks and not enough on the activity risks.'

Will mortgage rates stop rising?

Fixed rate mortgage pricing is largely based on Sonia swap rates - the inter-bank lending rate, which is based on future interest rate expectations.

When Sonia swaps rise sufficiently it often results in fixed mortgage rates going up, and vice versa when they fall.

Similar to gilt yields, Sonia swap rates have spiked upwards since the conflict began. Two-year swaps are at 4.24 per cent, up from 3.36 per cent on 27 February.

Meanwhile, five-year swaps are at 4.17 per cent, up from 3.41 per cent on 27 February.

As a result, mortgage rates have been on the rise, with the lowest rates going from around 3.5 per cent to well above 4 per cent since the conflict began.

Experts say much of the change in swaps has now filtered through into fixed rate mortgage pricing.

However, as with previous spikes, lenders will be quick to raise rates and slow to bring them down again.  

Peter Stimson, director of mortgages at the lender MPowered, says: 'Assuming a swift and conclusive resolution [to the conflict] in the next couple of weeks, swap rates should quickly drop back below 4.0 per cent as the "doomsday" scenarios are taken out of the swap pricing curve,' says Stimson.

'However, it will take a while for rates to come down to the levels we saw at the start of March, and it could be early 2027 before we see those levels and mortgage rates, back down to just above 3.5 per cent again.'