Inflation expectations among UK businesses have climbed to their highest level in more than two years, as the economic fallout from the Middle East conflict reshapes outlooks for prices, interest rates and growth.
New data from the Bank of England shows firms now expect inflation to reach 3.5 per cent over the next 12 months, up from 3 per cent previously and marking the highest year-ahead forecast since late 2023.
The shift reflects a sharp change in sentiment following the surge in energy prices triggered by the Iran conflict, with oil and gas costs rising significantly amid disruption to global supply routes.
Alongside higher inflation expectations, businesses are now anticipating far fewer interest rate cuts than previously forecast.
Before the conflict, financial markets had expected multiple reductions in borrowing costs over the next year. However, firms now believe there could be just one rate cut in the next 12 months, and only two by 2029, as persistent inflation limits the scope for monetary easing.
Brent crude has remained above $100 a barrel, reinforcing concerns that energy-driven inflation could prove more durable than previously thought.
The rise in inflation expectations is already feeding into business behaviour. Companies now expect to increase their prices by an average of 3.7 per cent over the coming year, up from 3.4 per cent in February.
Economists warn that the impact will extend beyond energy bills, with higher costs likely to filter through into food, transport and other essential goods.
Industry groups have already flagged the potential for grocery prices to rise by as much as 9 per cent by the end of the year, while household energy bills are expected to increase sharply when the next Ofgem price cap takes effect.
The data also suggests a shift in labour market expectations. Businesses now anticipate a slight contraction in employment over the coming year, reversing earlier projections for growth.
At the same time, expected wage growth has edged down slightly to 3.4 per cent, indicating that while inflation pressures are rising, firms may be less willing or able to increase pay.
This combination of higher prices and softer wage growth raises the risk of a squeeze on real incomes, with implications for consumer spending and overall economic activity.
The latest figures come against a backdrop of already fragile economic growth
The UK economy expanded by just 0.1 per cent in the final quarter of last year, and recent forecasts from the OECD suggest the country could face the weakest growth and highest inflation among G7 economies as a result of the conflict.
Rising borrowing costs are also adding pressure, with government bond yields remaining elevated compared with pre-conflict levels, reflecting investor concerns about inflation and fiscal constraints.
In addition to energy costs, companies are contending with a range of domestic pressures, including increases in the minimum wage and higher business rates.
These factors are compounding the impact of global shocks, creating a challenging environment for firms already operating with tight margins.
Elliott Jordan-Doak of Pantheon Macroeconomics said the surge in energy prices is already influencing business decisions.
“Higher costs are weighing on hiring plans and leading to increased price-setting intentions,” he said, although he noted that medium-term expectations remain relatively stable for now.
The rise in inflation expectations signals a turning point in the UK’s economic outlook, with the prospect of sustained price pressures reshaping both business strategy and monetary policy.
For the Bank of England, the challenge will be balancing the need to control inflation against the risk of further weakening growth.
For businesses and households, the implications are more immediate: higher costs, tighter financial conditions and a more uncertain economic environment in the months ahead.
