UK CPI inflation stayed at 3.0% year-on-year in February, matching Bank of England forecasts, after Nomura had expected 2.9%. Core measures eased slightly, while services inflation remained elevated.
Nomura’s estimate of the MPC’s services inflation excluding volatile and administrative prices slowed to 0.24% month-on-month (seasonally adjusted) in February, from 0.51% in January. The three-month moving average stayed high and above the level the BoE would prefer.
The Iran war is expected to raise energy and fuel costs, with weekly pump price data already showing higher prices in March. Inflation is expected to rise from March onwards.
Nomura has removed previously forecast Bank Rate cuts and now expects the BoE to keep rates unchanged for the rest of its forecast horizon. The BoE said March inflation would probably be about 0.5 percentage points higher than expected in February, at 3.5% year-on-year rather than 3.0%.
The BoE’s Q2 CPI forecast is now 3.0%, up from 2.1%. Based on energy futures, CPI could reach 3.5% by Q3, up from 2.0% in the MPR.
The outlook for UK rates has fundamentally shifted in recent weeks. While February’s 3.0% inflation was in line with forecasts, the conflict in Iran has introduced a new and persistent inflationary shock. We must now operate under the assumption that the Bank of England will keep rates higher for longer.
The impact is already being felt in commodity markets, with Brent crude futures having surged past $115 a barrel. This is feeding directly into the real economy, as weekly data shows the average price for petrol has already jumped by 8p a litre in March. We now see a clear path for headline inflation to hit the Bank’s revised 3.5% forecast by the summer.
As a result, interest rate markets have aggressively repriced expectations for the Bank of England. Overnight Index Swaps, which in February were pricing in a 50 basis point cut for the second half of the year, now indicate zero chance of a rate cut in 2026. Any trading positions based on anticipated monetary easing are now facing significant headwinds.
With the Bank’s path now highly uncertain, interest rate volatility has increased sharply. Implied volatility on 3-month SONIA options has nearly doubled this month, signalling that wide swings in rate expectations are likely to continue. This suggests that option-based strategies designed to profit from this instability could prove effective.
We are seeing a situation that is reminiscent of the energy shock of 2022, which forced central banks globally to pivot away from planned easing. This creates a stagflationary risk for the UK, putting downward pressure on the pound. Hedging against sterling weakness should now be a primary consideration.
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