British companies’ inflation expectations have risen to their highest level in more than two years as the economic fallout from the Middle East conflict changes the outlook for prices, interest rates and growth.
New data from the Bank of England shows that businesses now expect inflation to reach 3.5 percent over the next 12 months, up from 3 percent previously and the highest forecast for the coming year since the end of 2023.
The shift reflects a sharp shift in sentiment following the surge in energy prices triggered by the Iran conflict, with oil and gas costs rising significantly due to disruption to global supply routes.
In addition to higher inflation expectations, companies are now expecting significantly smaller interest rate cuts than previously forecast.
Before the conflict, financial markets had repeatedly expected borrowing costs to fall over the next year. However, companies now believe there could be just one rate cut in the next 12 months and just two by 2029 as persistent inflation limits the scope for monetary easing.
Brent crude remains above $100 a barrel, adding to fears that energy-related inflation could prove more permanent than previously thought.
The rise in inflation expectations is already impacting business behavior. Companies now expect to increase their prices by an average of 3.7 percent next year, up from 3.4 percent in February.
Economists warn that the impact goes beyond energy bills, with higher costs likely to spill over into food, transportation and other essential goods.
Industry groups have already flagged that food prices could rise by up to 9 per cent by the end of the year, while household energy bills are expected to rise sharply when the next Ofgem price cap comes into force.
The data also suggests a shift in labor market expectations. Companies are now expecting a slight decline in employment in the coming year, reversing previous growth forecasts.
At the same time, expected wage growth fell slightly to 3.4 percent, suggesting that inflationary pressures are increasing but companies may be less willing or able to increase wages.
This combination of higher prices and weaker wage growth increases the risk of pressure on real incomes, impacting consumer spending and overall economic activity.
The latest figures come against a backdrop of already fragile economic growth. Britain’s economy grew just 0.1 percent in the final quarter of last year and recent OECD forecasts suggest the country could face the weakest growth and highest inflation among G7 economies because of the conflict.
Rising borrowing costs are also increasing pressure as government bond yields remain high compared to pre-conflict levels, reflecting investor concerns about inflation and fiscal constraints.
In addition to energy costs, businesses are grappling with a range of domestic pressures, including minimum wage increases and higher business taxes.
These factors compound the impact of global shocks and create a challenging environment for companies already operating on thin margins.
Elliott Jordan-Doak of Pantheon Macroeconomics said the rise in energy prices is already influencing business decisions.
“Higher costs are weighing on hiring plans and leading to increased pricing intentions,” he said, but 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, as the prospect of continued price pressures will alter both business strategy and monetary policy.
The challenge for the Bank of England will be to balance the need to control inflation against the risk of a further slowdown in growth.
For businesses and households, the impact is more immediate: higher costs, tighter financial conditions and a more uncertain economic environment in the coming months.
