Why tensions in the Middle East are keeping British mortgage rates high

“With inflation recently easing, British borrowers had anticipated falling rates and cheaper monthly mortgage payments. Instead, disruption from America’s war in Iran has driven up inflation. Giray Gozgor and Erhan Kilincarslan explain why the “Hormuz effect” is keeping inflation and mortgage rates high, and how the Bank of England can respond. For much of the past year, the direction of travel for interest rates in Britain seemed clear. Inflation was easing, economic growth was weakening and households, after a prolonged cost-of-living crisis, were expecting relief. Under normal circumstances, this is exactly when central banks begin cutting rates. But that relief has not arrived. Borrowing costs remain stubbornly high, mortgage rates have not fallen as much or as fast as expected and financial markets signal that rates may stay elevated for longer. The reason is not simply domestic. It lies, in large part, in geopolitical tensions involving Iran and the way financial markets respond to them. At first glance, a conflict in the Middle East may appear distant from household finances in Britain. But in today’s interconnected financial system, such events spread rapidly through energy and bond markets – and ultimately into the cost of borrowing faced by ordinary households. The oil connection The key link begins with oil. Iran plays a central role in global energy supply and in critical transport routes such as the Strait of Hormuz . When geopolitical tensions rise, markets do not wait for actual disruptions; they price in risk immediately. Oil prices increase as traders anticipate potential supply constraints . This matters because energy prices feed directly into inflation. Petrol prices rise almost immediately, while household energy bills follow with a lag. Firms facing higher input costs pass these increases on to consumers. Economists call this a cost-push inflation shock . Prices rise not because demand is strong, but because production has become more expensive. This creates a difficult policy problem. Central banks can manage demand-driven inflation by raising interest rates. But supply-driven inflation is harder to control. Raising rates does not increase oil production or reduce geopolitical risk. However, failing to respond risks allowing inflation expectations to become embedded. How do bond markets transmit the shock? UK gilt markets play a central role in determining borrowing costs across the economy. Long-term interest rates reflect not just current policy but also investors’ expectations of future inflation and the risk premium for geopolitical risk . The Iran-related shock affects all of these. With higher energy prices pushing up inflation expectations , markets then reassess monetary policy: if inflation risks persist, the Bank of England is less likely to cut rates quickly . Geopolitical risk simultaneously increases the premium investors demand for holding long-term assets. The result is higher gilt yields , which underpin a wide range of borrowing costs across the economy. Why is your mortgage not getting cheaper? For households, the most important transmission channel is mortgages. In Britain, fixed-rate mortgage pricing is closely linked to swap rates and government bond yields. When yields rise, banks’ funding costs increase, and these are passed on to borrowers, meaning mortgage rates can remain high even without an explicit Bank of England rate hike. This explains a key puzzle: why are mortgage rates not falling despite easing inflation? Markets are forward-looking . If investors believe inflation risks remain due to geopolitical risks, they price in higher rates for longer. When global risks rise, the term premium for uncertainty increases alongside them. For the United Kingdom, these effects are amplified by its position as an energy-importing economy . If the pound weakens against the dollar during periods of uncertainty – as it often does – the impact is greater still. Oil is priced in dollars, so a weaker currency makes imports more expensive, further fuelling inflation. Higher energy prices raise inflation, higher inflation keeps interest rates elevated, and higher rates increase borrowing costs : a self-reinforcing loop. The squeeze on households The consequences are immediate and tangible. Millions of households are refinancing or expecting to do so in the coming months. Many had anticipated rates would fall in 2026 . Instead, they face significantly higher monthly repayments, not a short-term adjustment, but a sustained squeeze on disposable income. Higher rates, in turn, put downward pressure on house prices, reducing household wealth. Increased borrowing costs for firms can also suppress wage growth. Energy costs remain volatile. Petrol prices respond quickly to global oil markets, while household bills adjust more slowly but remain sensitive to the same forces. In this scenario, government policy offers limited relief. Rising gilt yields increase public borrowing costs, constraining the fiscal space available for subsidies or tax relief. The Bank, meanwhile, faces a genuine dilemma: cut too soon and risk losing credibility if inflation rebounds; wait too long and prolong the squeeze on households. The broader lesson In an interconnected global economy, interest rates are no longer determined solely by domestic conditions. Financial markets, geopolitical events and global supply shocks all play a decisive role. For British households, this means a conflict thousands of miles away can shape the cost of a mortgage, the price of fuel, and overall living standards. Interest rates should be falling. But as long as global risks keep inflation and uncertainty elevated, that relief may remain just out of reach. This article gives the views of the author, not the position of LSE Business Review or the London School of Economics. You are agreeing with our comment policy when you leave a comment. Image credit: Feng Yu provided by Shutterstock. The post Why tensions in the Middle East are keeping British mortgage rates high first appeared on LSE British Politics .

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