Monetary Policy Report - April 2026

Box A: How could conflict in the Middle East affect households?

The conflict in the Middle East has raised energy prices. Energy is a necessary purchase for households and an input that businesses must use for production throughout supply chains. Higher energy prices directly increase costs for households. Average petrol pump prices reached a little under 160 pence per litre in April, for example. There will also be indirect effects as higher energy costs pass through supply chains, and because the prices of other key input goods, for example fertilisers used for agriculture, have also increased. Higher inflation itself may also lead to upward pressure on prices, for example by encouraging higher wage growth which will further raise firms’ costs, although the extent of this is uncertain. Additional costs for households mean they are likely to cut back on spending. Higher inflation is unavoidable, at least in the short term, since the prices of energy imports have risen. But the MPC will set Bank Rate to ensure that energy costs do not lead to persistent inflation and that inflation returns sustainably to the 2% target.

Conflict in the Middle East has had a significant impact on the availability and price of a range of goods, particularly oil and natural gas. Transport through the Strait of Hormuz, a key shipping route, has been effectively closed and there is limited capacity on alternative export routes. This has pushed up energy prices globally.

Oil and gas prices directly affect UK households’ costs, via the cost of motor fuels and household utility bills. Oil prices peaked at a little under $120 per barrel on 31 March, up from $64 prior to the conflict, and natural gas prices peaked at over 150 pence per therm up from around 80 pence (Section 1.1). Despite falling back somewhat since then, wholesale prices are expected to remain elevated. As electricity prices in the UK tend to be driven, in part, by gas prices, electricity has also become more expensive.

Households mainly buy energy in the form of utilities supplied directly to the home, such as gas and electricity, and motor fuels, such as petrol and diesel. Some households also purchase other fuels to heat their homes. Purchases of energy made up around 8% of household spending in 2024 on average, although this varies widely. Utilities tend to comprise a larger proportion of lower income households’ spending (Chart A.1). Expenditure on motor fuels is less related to income but will still vary widely. For example, those in rural areas, where driving longer distances is typically required, are likely to be most affected.

Chart A.1: Low-income households are more exposed to cost increases than high-income households

Share of household spending on categories particularly exposed to energy-driven price rises, by income decile ^(a)

Footnotes

• Source: ONS.
• (a) Data are for 2025 although the weights for 2025 are assumed to be the same as for 2024 and so are likely to be revised.

The price of household motor fuels tends to move quickly as global oil prices rise. Average petrol pump prices have risen from just over 130 pence in February, prior to the conflict, to around 157 pence per litre in the first three weeks of April, and diesel has risen by more to 190p. This is expected to add around 0.7 percentage points to April CPI inflation, relative to the projection in the February 2026 Report (Section 1.1).

Household gas and electricity prices are somewhat slower to increase following wholesale cost increases. A price cap on gas and electricity, set by the energy regulator, Ofgem, affects how much most households pay for their utilities. Energy suppliers tend to purchase gas weeks or months in advance of using it, and these prices are taken into account when Ofgem calculates the energy price cap. The cap is now expected to rise to close to £1,900 in 2026 Q3 from £1,641 in Q2. This remains well below the £4,279 peak the cap would have reached in early 2023 had the Government not introduced the Energy Price Guarantee (EPG). The price cap in future quarters is more uncertain as energy prices continue to evolve, but it is currently expected to remain around £1,900 in 2026 Q4. These figures are for households paying via direct debit; the cap for those paying via prepayment meter and standard credit is set at different levels, although the movements will be similar to that for direct debit customers.

Not all households face the same change in utility prices at the same time. Close to 40% of households are on fixed tariffs for electricity and gas, and this is higher than the roughly 25% of households with fixed tariffs when Russia invaded Ukraine in 2022 Q1. These households will be protected from higher prices until their contracts end. Around 1.5 million households rely on heating oil, however, for which prices have already risen. This is particularly common in Northern Ireland, where over half of households use heating oil. The Government has provided £50 million of support for low-income households relying on heating oil.

The time of year is also important for the economic impact of higher energy prices. For example, around three in ten households pay for utilities via prepayment meters or via standard credit tariffs. These households are less affected by an immediate cost increase because they can use less energy during the warmer summer months. If prices are still high in the winter, then these households will face larger rises in costs. Other households pay for utilities via direct debit which allows them to spread their payments evenly throughout the year.

Overall, the direct effect of higher energy prices for households is likely to add 0.9 percentage points to CPI inflation by 2026 Q3, compared with the projection in the February Report.

The prices of non-energy products are likely to rise as well, reducing household real incomes.

Households will also be affected by higher energy prices as firms pass on their own higher energy costs to consumer prices. Many firms plan to pass on these cost increases to some extent (Box B). These indirect cost increases are expected to add a further 0.3 percentage points to CPI inflation in 2026 Q3 (Section 1.1).

Consumer food prices are expected to rise this year reflecting higher energy and transport costs (Section 1.1). Food prices may also rise further out due to increases in the cost of fertiliser. Around a third of global fertiliser exports typically go through the Strait of Hormuz as natural gas can be used to produce ammonia, an important component of fertilisers (Box F). The reduction in exports has led to a rapid increase in fertiliser costs which will raise the production costs of farmers. In addition, less fertiliser available to use means that global crop yields will be lower. Agents’ contacts report that many UK farmers have already purchased fertilisers for this season and so are not facing an immediate increase in costs, but higher fertiliser costs may be important in the longer term.

Low-income households, on average, spend close to twice as much on food as a share of their expenditure compared with high-income households (Chart A.1). That means the effect on real incomes for low-income households will be larger than for others.

There are a range of other cost increases that may also be material, and these cost increases may be persistent. For example, some other raw materials, such as aluminium and other inputs to semiconductors, have risen in price. These cost increases will pass-through to the prices that households pay over time.

Higher inflation itself may also lead to further upward pressure on prices. This is often termed second-round effects from a rise in inflation. Second-round effects could result, for example, from firms raising wages to maintain pay growth in line with inflation for their employees, which would increase their costs and could lead to firms setting higher prices. It could also be driven by higher inflation expectations. But the extent of second-round effects is uncertain and will depend on a range of factors (Box C). Monetary policy cannot prevent higher inflation in the short term, which is due to the prices of energy imports having risen. But the MPC will set Bank Rate to ensure that energy costs do not lead to persistent inflation and that inflation returns sustainably to the 2% target (Box G).

Lower household real incomes will likely lead to somewhat lower consumption.

Higher energy prices will reduce real household incomes, the incomes households receive after taking account of changes in prices. Households are likely to reduce their real spending in response, but by less than the fall in incomes (Box E). Following the 2022 energy price shock, household real incomes fell but consumption remained broadly stable before falling back in 2023. This was partly a result of government policy, such as the EPG, which reduced household bills and allowed households to maintain their consumption. But, based on historical experience, it is likely that households will again partly maintain their consumption through the latest fall in real incomes.

Box B: How might firms respond to higher energy prices?

Higher energy prices raise costs for firms and erode customers’ real incomes, which can reduce demand for the goods and services firms sell. Firms will need to respond to the energy shock and can do so in several ways, including by allowing their profit margins to fall, raising their prices, reducing costs and reducing output. The balance of these responses across firms will partly determine the extent to which the rise in energy costs feeds through to CPI inflation. Early evidence suggests that, while firms expect to raise prices, they may not be able to pass through the full rise in costs and so their profit margins are likely to fall. Compared with the energy shock in 2022 following the Russian invasion of Ukraine, weaker demand and a looser labour market mean that firms may also respond to the shock by reducing their wage bills, although survey responses currently suggest only modest expected impacts on pay and employment growth. Firms’ actions may change depending on the size and duration of the energy shock, as well as on how households react to lower real incomes, and to any monetary or fiscal policy response.

How are firms exposed to higher energy prices?

Global energy prices have risen significantly since the outbreak of the Middle East conflict (Section 1.1). Firms use energy in the form of oil, gas and electricity to produce their outputs. Higher energy costs therefore represent a direct increase in overall costs for firms, and a negative supply shock for the UK economy as it is a net importer of energy.

The extent of the direct rise in costs varies significantly by firm. Direct spending on energy, based on the latest data from 2023, averages around 3% of non-energy sector firms’ intermediate consumption and labour costs. But there is wide variation across industries: for example, energy is an average of 0.3% of insurance firms’ intermediate consumption and labour costs, compared with 5.1% for accommodation firms and 29.6% for air transport firms.

The timing of the increase in costs also varies across firms. Nearly 60% of firms report having a fixed-price contract for gas (Chart B.1) and similar numbers report the same for electricity. These shares have risen somewhat since 2022. Small firms are significantly less likely to purchase energy on fixed rates than the average across firms. Contract length varies, with around half of firms with 10 or more employees reporting having at least six months before their gas price is reset. This suggests it will take time for direct energy costs to feed through fully for many firms, and if energy prices were to fall back quickly enough some firms may not be affected directly at all. There is also a range of typical energy contracts across sectors. For example, construction and education firms are much less likely to have fixed gas contracts.

Chart B.1: Energy price rises will affect many firms with a lag due to fixed-price contracts

Share of firms with a fixed-price gas contract ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) Long-term fixed contracts represent contracts lasting six months or longer. Some industries only have survey responses for 2026. Business size is split by employee numbers. ‘Not applicable’ and ‘Not sure’ responses are excluded from the gas contract responses with the remaining answers rescaled to equal 100%. Data are from the ONS’ Business Insights and Conditions Survey.

Besides the direct impact of higher energy costs, firms also face an indirect increase in costs as the energy shock spreads through supply chains. For example, higher fuel prices will raise the costs of transporting goods which will be reflected in the costs of non-energy inputs for firms. This will magnify the effect of higher energy costs but will feed through with a lag.

Higher energy prices will also lead to a reduction in aggregate demand because, since the UK is a net energy importer, higher energy costs represent a real cut in domestic incomes. That reduction in demand is also likely to affect firms gradually and will depend on how households respond to rising costs (Box E).

How can firms respond to higher energy prices and how might it differ from the response in 2022?

Firms can respond to higher energy prices in several ways, each of which could have differing effects on the inflationary impact of the shock, which in turn will affect the necessary monetary policy response. It will be important for policymakers to monitor the relative importance of these responses over coming months.

Firms could choose not to increase prices or take actions to reduce other costs. This would mean that higher energy costs would result in lower profits because firms would set a smaller mark-up between the cost of producing their output and the prices they charge. Following past energy price rises firms’ mark-ups fell and stayed persistently lower for several years (Manuel et al (2024)). This is likely to happen in response to the recent rise in energy prices as well, with 68% of firms responding to the latest DMP survey reporting that they expect lower margins over the next year as a result of higher energy costs (Chart B.2).

Reductions in margins may be smaller than in response to past energy shocks because they are already compressed. Agents’ contacts typically report lower margins than in 2022 and so fewer firms may be able to lower them further to absorb the cost increases. That said, historical evidence shows that in the aftermath of the 1979 oil price shock, mark-ups fell further even though they had yet to recover to levels prior to the 1973 oil price shock.

Chart B.2: Higher prices and lower profit margins are the most common responses from firms in response to higher energy costs

Share of firms reporting how they expect the increase in energy prices to affect aspects of their business over the next year ^(a)

Footnotes

• Source: DMP survey.
• (a) Responses were collected between 2–17 April 2026. Results show weighted responses to the question ‘The war in Iran has led to higher energy prices. How do you expect these increases in energy prices to affect the following aspects of your business over the next year?’.

Firms may also respond to higher costs by raising their output prices. 64% of firms responding to the latest DMP survey are expecting to increase prices as a response to energy costs over the next year. And the average of firms’ own output price growth expectations for the year ahead was 4.4% in April, compared with 3.4% in January (Chart B.3).

Chart B.3: Firms’ expectations for price growth have increased markedly since energy prices rose, but wage growth expectations are little changed

Firms’ reported expectations for their own price and wage growth ^(a)

Footnotes

• Source: DMP survey.
• (a) Data are responses from the individual monthly surveys.

Evidence suggests that firms’ own price expectations have become more sensitive to increases in headline inflation and that firms are changing prices more frequently than in the past. This may mean that the initial rise in prices is larger than it would have been historically. The proportion of firms changing prices in response to changing economic conditions compared with those setting prices at fixed intervals, for example, has increased in recent years, peaking at 58% in March 2023 compared with a pre-pandemic estimate of 44%. This proportion has fallen back a little in recent years, to closer to 50%. These firms tend to exhibit faster pass-through of oil and gas supply shocks than time-dependent firms who adjust prices at regular intervals (Bunn et al (2026)).

On balance, Agents’ contacts expect to pass on at least some of their additional costs because their profit margins are already squeezed. Contacts thought that customers might be willing to accept higher prices given the highly visible increase in input costs, although lower household real incomes and higher interest rates could reduce the extent to which such pass-through is possible (ASBC – April 2026). Indeed, a little over half of firms report expecting sales volumes to fall in response to higher energy prices (Chart B.2).

Rather than raising prices or reducing profit margins, firms could respond to higher energy costs by reducing other input costs, particularly their wage bill as this tends to be the largest cost for most firms and easier to change than fixed costs such as buildings. Labour market conditions are significantly looser now than in 2022, which may make it easier for firms to reduce wage growth compared with what wage growth would have been absent energy price rises, since there is less competition for available workers (Box D). Partly set against this is the fact that firms cannot reduce wages for workers on the National Living Wage (NLW), and there has been a slight increase in the NLW coverage rate of around one percentage point between 2022 and April 2025, when it was 6.6% of employees.

Consistent with firms having some capacity to reduce wage growth, nominal wage growth expectations in the DMP survey are little changed since the February Report. Firms responding in April on average expected wage growth of 3.5% over the next year, the same as in the January survey (Chart B.3).

Any adjustment to wages in response to the energy shock is likely to vary across firms as they balance the need to reduce costs with potential pressures to raise nominal wage growth as their employees face higher inflation. While wage expectations reported in the DMP survey are unchanged since the February Report, 26% of firms report that higher energy prices will lead them to raise wage growth over the year ahead (Chart B.2). Past evidence suggests that around 40% of employees work at firms that set wages using a ‘cost minimiser’ approach (Box B, February 2026 Monetary Policy Report), where labour market conditions, including policies such as the NLW, are the main drivers of wage growth. Looser labour market conditions should generally limit increases in wage growth. In contrast, around half of workers are employed at firms that tend to put relatively greater emphasis on changes in inflation, albeit with a lag, for example as a result of wage bargaining with their workers. In either case, any adjustment to wages is likely to happen largely in 2027, as wage settlements for 2026 are generally already fixed (Section 1.1).

Firms can also reduce employment costs by reducing the number of people they employ or employees’ average hours worked. Firms may be more likely to use this margin of adjustment in response to the latest energy price increase than in 2022, when some Agents’ contacts reported hoarding labour whereby firms continued to employ workers despite lower output given worries about recruiting in the future. Current measures of recruitment difficulty are materially lower than in 2022, meaning that firms may be less concerned about rehiring staff in the future. In addition, although judged to be still resilient in aggregate (Financial Policy Committee Record – April 2026), small firms' balance sheets are on average slightly weaker than in early 2022 and some firms have higher debt servicing costs. Evidence from the DMP survey suggests that weaker balance sheet positions are associated with firms choosing to reduce their own employment by slightly more when facing a fall in income.

Initial evidence suggests that the energy cost rise has had less impact on firms’ future employment expectations than it has on other potential responses such as output prices and margins, however. Two-thirds of firms responding to the DMP survey reported that they expected higher energy prices to have no impact on their employment (Chart B.2). And Agents’ contacts generally point to employment remaining at around current levels. These responses may change as the shock continues to propagate.

Firms can also attempt to reduce other costs in response to higher energy prices. They might reduce energy costs directly, for example, by reducing their usage of energy or substituting to alternative sources. This was an important margin of adjustment in 2022 when average energy consumption by firms fell. Some Agents’ contacts have reported efforts to substitute to other energy sources, such as by installing solar panels.

Overall, early evidence suggests that, although firms do expect to absorb some of the rise in energy costs within their margins, most firms also expect to raise prices somewhat in response to the shock. There are fewer signs that firms are expecting to raise wage growth, consistent with there being spare capacity in the labour market. Expectations for employment also appear to be little changed.

How might overall supply capacity in the UK be affected by the energy price shock?

Firms’ responses to the energy price shock will also affect the supply capacity of the economy. The outlook for inflation will depend in part on the impact of the energy price shock on the relative balance of supply and demand. The impact on potential supply capacity is uncertain but likely to be negative. Bank staff’s central forecasting models suggests that around 20% of the total GDP reduction will be matched by a fall in potential GDP, meaning that – while spare capacity is likely to widen as a result of the shock – potential supply will also fall. Supply capacity can be reduced through several channels, including: lower investment reducing the future capital stock, firm closures, a rise in long-term unemployment, or other hysteresis effects associated with a weaker economy. The relative importance of each channel is uncertain, particularly as the scale and persistence of the shock is unknown. And, in the event of constraints in energy supply, the decline in potential output would be larger.

Given the uncertainty in the size and timing of the shock, and in how firms will respond to it, the MPC will continue to monitor the emerging evidence on the actions firms are taking and how that will affect the outlook for inflation.

Box C: How will prevailing economic conditions affect the impact of the energy shock on inflation?

A key question for monetary policy is whether the latest increase in energy prices will give rise to material second‑round effects on inflation, absent a sufficient monetary policy response. Evidence suggests that the transmission of oil supply shocks can depend on the current inflation environment as well as the degree of tightness in the labour market. Updated evidence from a non-linear time series model (Box C of the November 2025 Monetary Policy Report) finds that, while the impact of energy price shocks on inflation tends to be amplified by rising inflation expectations when CPI inflation is elevated, the inflation response tends to be much weaker when there is spare capacity in the labour market. This suggests that current labour market slack will reduce the risk of second-round effects from the latest energy shock. There are some risks around this conclusion. Increased responsiveness of household inflation expectations to rises in prices, for example, could mean that the most recent rise in energy prices evolves differently to past energy shocks.

The persistence of any rise in inflation following an energy price shock will depend partly on recent inflation dynamics and spare capacity in the economy. When prevailing inflation is elevated, households and firms may pay closer attention to a renewed bout of price increases such that their expectations for future inflation are more likely to rise. That can feed into wage bargaining and price-setting decisions meaning that an energy price shock leads to more persistent inflation. The presence of spare capacity in the economy, either in the form of under-utilised capacity within firms or of slack in the labour market, may reduce the risk of this outcome occurring. When the labour market is looser, workers will tend to have less bargaining power over their wages. Firms may then be able to absorb some of the rise in costs by raising wages to a lesser degree than otherwise.

How do inflation and labour market conditions differ from 2022?

Annual CPI inflation averaged 3.3% in the six months to February ahead of the conflict in the Middle East, well below the elevated rates seen in recent years but a little above the level at which previous analysis has suggested energy shocks are more likely to be amplified through higher inflation expectations (Box C of the November 2025 Monetary Policy Report). By contrast, ahead of Russia’s invasion of Ukraine in 2022, CPI inflation had already risen sharply to around 6%, in part due to a substantial rise in fuel prices over the preceding year.

Short-term household inflation expectations at the start of this year were somewhat lower than in 2022 (Section 1.1). They have since risen sharply but remain below their levels during the 2022 energy shock. Labour market conditions are considerably looser than four years ago (Section 1.2), when the labour market was exceptionally tight. That tightness reduced firms’ scope to absorb higher energy costs through lower real wages.

How have labour market tightness and prevailing inflation affected the transmission of past energy shocks to inflation?

Bank Staff have extended the self-exciting threshold Bayesian vector autoregression (SET-BVAR) model presented in Box C of the November 2025 Monetary Policy Report to allow for state-dependencies with regard to different degrees of labour market tightness alongside prevailing inflation. The model estimates the most likely level of inflation at which shifts in inflation behaviour become more probable using past observed historical associations between inflation, inflation expectations, and global shocks. The results presented below are based on the median threshold presented in Box C of the November 2025 Monetary Policy Report, of 3.1%. Low and high inflation regimes – that is, those with prevailing CPI inflation below and above 3.1% – are then split further into periods of tight and loose labour markets which are identified according to whether the vacancies to unemployment ratio is above or below its estimated trend (Stelmach et al (2025)).

The results of this model are shown in Charts C.1 and C.2. The panels in the former display responses to an adverse energy shock conditional on inflation starting above the 3.1% estimated threshold. Those in the latter display the estimated responses when inflation is below that threshold when the shock occurs. Across all panels in Charts C.1 and C.2, the aqua and orange lines (and associated credibility intervals) refer to the cases where the labour market is tight or loose, respectively. The panels on the left show the response of inflation and those on the right show the associated response of one-year-ahead household inflation expectations.

Chart C.1: Energy supply shocks have had a larger impact on inflation when the labour market has been tight

Estimated impulse response functions of CPI inflation and inflation expectations to an adverse oil supply shock when inflation is above 3.1% ^(a)

Footnotes

• Sources: Bank of England, Citi/YouGov, Känzig (2021), LSEG, ONS, Stelmach et al (2025), and Bank calculations.
• (a) The sample period is January 1989–June 2025; data are monthly. Generalised impulse response functions (GIRFs) to an oil supply news shock by Känzig (2021) that raises sterling oil prices by 10% on impact, from a self-exciting threshold Bayesian vector autoregression that endogenously estimates an inflation threshold (following Gargiulo et al (2026)). The partitioning of the sample yields four regimes in total, with piecewise-linear coefficients across regimes. Bayesian estimation is used. The GIRFs account for regime changes over the propagation horizon. The lines represent the median estimate, and shaded areas show the 68% credibility interval. Results remain broadly similar over an extended sample starting in January 1976, which yields a larger number of observations by regime and allows for the inclusion of more control variables, and when using a filtered unemployment gap as the labour market slack measure. Household inflation expectations refer to the one-year-ahead measure from the Citi/YouGov survey.

These results suggest that during periods when inflation was elevated, a higher degree of labour market tightness meant that global oil supply shocks led to a stronger and more persistent rise in inflation. This is shown in the left panel of Chart C.1, where the response of inflation remains muted if there is spare capacity in the labour market (orange line) but is larger and more persistent when the labour market is tight (aqua line). The model suggests that the difference in response between the two labour market regimes is at least in part related to the dynamics of household inflation expectations, which have tended to rise sharply during periods when the labour market has been tight (aqua line, right panel) but not otherwise (orange line, right panel), even when prevailing inflation has been elevated. These findings are consistent with greater labour market slack allowing firms to absorb a greater portion of cost pressures through weaker pay growth, moderating workers’ real-wage expectations and reducing pass-through to CPI inflation.

Chart C.2: The inflationary impact of energy supply shocks has been smaller when the prevailing rate of inflation has been lower

Estimated impulse response functions of CPI inflation and inflation expectations to an adverse oil supply shock when inflation is below 3.1% ^(a)

Footnotes

• (a) Refer to Chart C.1 for model details.

There are reasons for caution, however, when drawing conclusions from these results for the current situation, and it is possible that current inflation conditions lead to more persistent inflation following the most recent energy shock. First, higher inflation does appear to play a role in amplifying the inflation response, at least in situations where the labour market has been tight (comparing the aqua lines in the left panels of Charts C.1 and C.2). This amplifying role is not evident in the case where inflation is elevated and the labour market is loose (Chart C.1, orange line in the left panel), but these results are based on a particularly small number of observations.

Second, household inflation expectations have risen sharply in response to the current energy shock whereas in the past they have remained stable when labour market conditions have been loose (orange lines in the right panels of Charts C.1 and C.2). The recent rise in household inflation expectations is consistent with households having a heightened awareness of inflationary developments. Repeated high inflation episodes – for example over the past five years – may have raised households’ attentiveness to price changes (Pfauti (2024)), especially among salient items (Box E of the August 2025 Monetary Policy Report). Consistent with that, previously published analysis showed that household inflation expectations have become more responsive to inflation outturns compared with the pre-Covid period (Anesti et al (2025)). Internet search data provide another signal of household inflation attentiveness (Buelens (2023)). Whereas Google searches for ‘inflation’ rose modestly and then receded in previous inflationary episodes, search interest since 2021–22 has declined only gradually and has risen again this year.

Increased responsiveness of inflation expectations to realised inflation developments could pose upside risks to the extent of second-round effects, relative to the estimates presented above. Rises in household inflation expectations may mean that households bargain more strongly for wage increases, for example. The extent to which this is passed through into higher wage settlements may be limited given spare capacity in the labour market (Section 1.2). But pass-through will also depend on firms’ pricing decisions (Box B). To the extent that firms pass through a large portion of the rise in energy costs to consumer prices, for example, that could lead to wage demands from households that are higher than otherwise.

Box D: What do industry-level data imply for the risks to unemployment?

The unemployment rate has risen over the past couple of years and is expected to rise further (Section 3). The rise in unemployment so far has been unevenly distributed across industries and dispersion in unemployment rates has increased. That could potentially mean there is less slack in the labour market than indicated by the decline in the aggregate vacancies to unemployment (V/U) ratio. Industry-level data may also point to upside risks to unemployment, including in light of the recent energy price shock. Firms in some industries – particularly accommodation and food services – appear particularly vulnerable. Given that unemployment has already risen in these industries and vacancy rates are low, these vulnerabilities could pose an upside risk to the aggregate unemployment outlook. But if workers displaced from these industries are also less able to move into vacancies elsewhere, then not all of that increase in unemployment may be associated with a rise in effective labour market slack.

How has the recent rise in unemployment varied across industries?

Having been exceptionally tight over 2022–24, conditions in the labour market have loosened over the past couple of years. The unemployment rate was 4.9% in the three months to February, up from 3.6% in the three months to July 2022, and the V/U ratio has fallen below its equilibrium level (Section 1.2).

That rise in unemployment has not been evenly distributed across industries. Chart D.1 shows how unemployment rates across industries have evolved since 2022. The shaded area, which captures the range across industries, provides a simple measure of dispersion in industrial unemployment rates. This dispersion has become more elevated recently and is somewhat wider than its 2001–19 average, indicating a more uneven distribution of unemployment across the economy.

In principle, increased dispersion in industry-level unemployment could indicate that workers are less able than in the past to move into available vacancies in other industries. If so, then effective labour market slack – which reflects not just the amount of spare capacity, but how easily unemployed workers can take up available jobs – may not be as much as indicated by the low level of the V/U ratio.

Chart D.1: Dispersion in unemployment rates across industries has increased

Unemployment rates by previous industry ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) Data show ONS estimates of unemployment by previous industry. This measure will not fully capture new entrants to the labour market who do not find a job as they have no previous industry, nor will it reflect the capacity for workers to transition across industries. The shaded area shows the range of industry-level unemployment rates by previous industry over time. Given data limitations and relatively small sample sizes, it can be difficult to draw firm conclusions from changes in these data. These data are not seasonally adjusted. The latest data shown are for the three months to February 2026.

How vulnerable is industry-level unemployment to the latest energy shock?

The uneven rise in unemployment across industries could suggest upside risks to aggregate unemployment from here in light of the latest energy shock. Industries in which unemployment has already risen and vacancy rates are relatively low may be more likely to experience a further increase in unemployment if labour demand weakens. Looser labour market conditions mean that workers who become unemployed may then find it hard to move quickly back into work. If firms in these industries are particularly exposed to the energy price shock – for example because they are vulnerable to a fall in discretionary consumer spending – it is possible that aggregate unemployment could rise by more than expected.

The relationship between vacancies and unemployment can be represented by the Beveridge curve. As explained in Box E of the November 2025 Monetary Policy Report, the economy has recently been operating on a ‘flatter’ part of the Beveridge curve, meaning that weak demand has been accompanied to a greater extent by rising unemployment rather than further reductions in vacancies.

Chart D.2 illustrates the Beveridge curve relationship for two industries that have experienced relatively large rises in unemployment in recent years (Chart D.1). Given data limitations and small sample sizes, it can be difficult to draw firm conclusions from changes in the industry-level vacancy and unemployment relationship over time. Nevertheless, compared with dynamics between 2001 and 2019, the purple dots in Chart D.2 suggest tentative evidence that the link between vacancies and unemployment has changed in these industries since 2025, with unemployment now responding a little more sharply to falls in labour demand. The relationship between unemployment and vacancies for these industries also appears a little flatter than that implied by the aggregate Beveridge curve.

Within accommodation and food services, unemployment has risen notably since early 2025 while vacancy rates are relatively low (Chart D.2, purple dots in left panel). This could reflect a sustained period of rising labour costs following increases in the National Living Wage (NLW) and employer National Insurance Contributions (NICs), in conjunction with subdued labour demand. Given the high concentration of low‑paid jobs in the industry, the resulting cost pressures may have been particularly acute, reducing firms’ scope to adjust employment solely through hiring.

The professional, scientific and technical activities industry has also seen fairly low vacancy rates alongside a notable rise in unemployment in recent years (Chart D.2, purple dots in right panel). This shift in labour market dynamics has been associated with both slower hiring and an increase in redundancies. Agency intelligence links this in part to developments in automation and AI, which may have reduced demand for labour. Recruitment in the industry has meanwhile become increasingly concentrated in specialist, high‑skill roles, leading to a degree of mismatch between the skills demanded and those held by available workers.

Chart D.2: Some industries appear particularly exposed to further increases in unemployment

Industry-level job vacancy and unemployment rates ^(a)

Footnotes

• Sources: ONS and Bank calculations.
• (a) The left panel shows data for the accommodation and food services industry (ONS SIC I) and the right panel shows the professional, scientific and technical activities industry (ONS SIC M). ONS vacancies by industry are plotted against ONS estimates of unemployment by previous industry. The latter will not fully capture new entrants to the labour market who do not find a job as they have no previous industry, nor will it reflect the capacity for workers to transition across industries. The aqua line is a simple linear trend based on the 2001−19 data. Data are available quarterly until 2018 Q1 and are shown monthly (on a three-month rolling average basis) thereafter. The Covid period has been excluded due to data volatility. These data are not seasonally adjusted. The latest data, which are indicated in the white diamonds, are for the three months to February 2026.

The energy price shock will raise input costs for firms, who will need to respond by raising prices, reducing margins or reducing costs (Box B). Intelligence from the Bank’s Agents and DMP survey suggests little evidence so far of the energy price shock having affected firms’ employment decisions (Box B and Section 1.2), though contacts note that employment and investment plans could be pared back if the shock were to persist or intensify. The outlook for unemployment will depend in part on any monetary and fiscal response to the energy shock.

Risks to the outlook for unemployment appear particularly pronounced for the hospitality sector, including accommodation and food which represents around 7% of total private sector employment. While this industry is not particularly energy intensive, a high share of spending on accommodation and food services is discretionary, meaning that it is more likely to be cut if household real incomes fall. Consistent with that, the industry experienced a rise in unemployment immediately after the previous energy shock in 2022. And a higher than average proportion of accommodation and food services firms responding to the latest ONS BICS have reported being ‘very concerned’ about energy prices, despite their relatively low use of energy.

There are some reasons to believe that hospitality sector unemployment could rise by more in response to the current energy shock than in 2022. While most aggregate indicators do not point to acute financial stress at present, with limited signs of a sharp pickup in the company insolvency rate or across a range of redundancy indicators, vulnerabilities appear more pronounced in parts of this sector. Industrial breakdowns of Experian data suggest that accommodation and food services has one of the highest shares of firms reporting particularly low cash positions among small and medium-sized enterprises, with around 80% holding cash worth less than one month of turnover, a higher share than in 2022. This may limit these firms’ ability to retain workers in the face of continued demand weakness. Intelligence from the Bank’s Agents suggests that hiring intentions in the hospitality sector have been particularly weak compared with other sectors, which have shown some tentative improvement in recent months.

Overall, the industry‑level evidence suggests that labour market loosening has been uneven across sectors and that some industries, such as accommodation and food, may be more vulnerable than others to a further increase in unemployment if demand weakens. Where those industries have already seen a rise in unemployment and vacancy rates are relatively low, there may be fewer opportunities for displaced workers to move quickly back into employment. That could increase the risk that further weakness in demand leads to a larger than expected rise in aggregate unemployment. If workers displaced from these sectors are also less able to move into vacancies elsewhere, some of that increase in unemployment could prove persistent, and may therefore be associated with a smaller increase in effective labour market slack.

Box E: How resilient will household spending be to the rise in energy prices?

The recent rise in energy prices will reduce households’ real incomes. Households tend to reduce consumption by less than any falls in their real incomes, especially when those falls are expected to be temporary. This is known as consumption smoothing. As in 2022 following the previous energy price shock, the financial positions of households appear consistent with households collectively having the capacity to partially smooth their consumption through the recent energy price rise. That consumption response is uncertain, however, and perceptions that the rise in energy prices will be permanent or very long-lasting, or that job losses will increase, could mean that spending falls more sharply. Recent increases in expected mortgage rates will also weigh on consumption, in part because higher mortgage payments will weigh on mortgagor households’ disposable incomes.

Higher energy prices will reduce real incomes for UK households (Box A). Lower real incomes would typically be associated with lower real household consumption. But declines in consumption are usually smaller than in incomes as households – perhaps expecting the reduction in income to be temporary – tend to partially smooth their consumption in response to the shock. To do this, households may reduce the pace at which they are currently saving, draw down on existing savings or increase borrowing.

The extent of consumption smoothing will partly depend on whether households have available savings to use or are able to access credit. This is the focus of the remainder of the box. But it will also depend on how households expect the income shock to evolve. If households judge the rise in energy prices to be temporary, they may be more willing to maintain their current consumption by using savings or borrowing. Following the initial rise in energy prices in 2022, the aggregate household saving ratio fell from 7.5% to 4% between Q1 and Q2, suggesting that households smoothed through part of the fall in real incomes over that period. The saving ratio rose after that, in part due to the restrictive stance of monetary policy.

As households have experienced a protracted period of high energy prices over recent years, they may be more likely to perceive the latest shock as permanent and consequently to reduce consumption. Periods of higher and more volatile inflation can also increase uncertainty around future real incomes which may further weigh on the consumption of some households (Mann (2025)). In addition, working-age households may be less willing to smooth their consumption if they are worried about the risk of job losses causing further falls in income. Unemployment is higher, and job vacancies lower, than in 2022 (Box D), although the share of households reporting having saved more money due to concerns about job loss in response to the 2026 H1 Bank of England/NMG survey remained low.

The extent of consumption smoothing will be important in determining the impact of the energy shock on demand in the economy and therefore the potential trade-off that the MPC faces between the speed at which inflation is returned to the 2% target while avoiding undesirable volatility in output (Box G).

Do households have enough savings to smooth consumption?

Some households may choose to maintain consumption by saving less. There appears to be capacity overall for households to smooth consumption in this way, although households who save very little – for example those on lower incomes – may not be able to do so. The household saving ratio was 9.9% in 2025 Q4, above historical averages and the 7.5% recorded in 2022 Q1. That suggests there is room for the saving ratio to decline, allowing households to at least partly maintain real consumption even with reduced real incomes.

Households may also be able to smooth consumption if they do not face liquidity constraints, for example if they have existing savings to fall back on. In aggregate, the stock of household bank deposits has fallen relative to incomes since it peaked in 2021–22, suggesting less capacity for consumption smoothing than was the case during the 2022 energy price shock. However, aggregate deposits remain higher than pre-pandemic and, according to alternative data on household savings and income from the 2026 H1 NMG survey, the median level of household savings relative to income is slightly higher than in 2022. This evidence also suggests some capacity for households to smooth their consumption through the recent rise in energy prices.

Aggregate data on household savings mask differences across households, however. The rise in energy prices is likely to disproportionately reduce real incomes for lower-income households because utility bills make up a larger-than-average share of their expenditure (Box A). Consistent with that, evidence from the 2022 H2 NMG survey indicates that lower-income households cut back consumption by more than higher-income households after the energy price shock in 2022 (Chart E.1, purple bars in left panel). The share of lower-income households with savings worth less than two weeks of income is greater than in 2022 (Chart E.1, right panel), all else equal suggesting that any reduction in consumption could be greater than during the last energy shock for these households.

Acting in the opposite direction, however, a fall in the proportion of liquidity-constrained high-income households could mean that the overall degree of consumption smoothing is somewhat greater than in 2022. Since 2022, there has been a modest fall in the share of high-income households with savings worth less than two weeks of income (Chart E.1, right panel). Higher-income households account for a disproportionate share of discretionary consumption, which can be more easily reduced than spending on essentials when incomes fall. As such, the fall in the share of higher-income households with few savings could mean that consumption smoothing is somewhat greater than during the previous energy shock.

Chart E.1: Evidence from the 2022 energy price shock suggests that lower-income households experiencing higher costs were more likely to cut spending; there is a lower share of financially insecure high-income households than in 2022

Actions taken by households in response to higher costs; ^(a) share of households with deposits worth less than two weeks of income ^(b)

Footnotes

• Sources: Bank of England/NMG survey and Bank calculations.
• (a) The data are from the September 2022 NMG survey. The bars show the share of respondents within each quintile of the non-equivalised total household gross income distribution for all households answering how their total spending had been affected by the increase in the cost of living over the past six months, excluding those who responded ‘Don’t know’. The full responses corresponding to the aqua, orange and purple bars were ‘Buying the same things or more, despite higher cost’, ‘Cutting back on some things but not others, spending more money overall’ and ‘Cutting back completely, spending the same money or less’, respectively.
• (b) The data are from the March 2022 and March 2026 NMG surveys. Low and high-income households are defined as those in the lowest fifth and the highest fifth of the non-equivalised total household gross income distribution for non-retired households, respectively. In addition to the standard cleaning procedures applied to each wave of the survey, further targeted cleaning was applied to the data for 2026 H1 to exclude a small number of implausible respondents concentrated in younger age cohorts. Observations with implausibly high income or savings were excluded using thresholds based on the 95th percentile of outcomes observed among prime age respondents. Following these exclusions, survey weights were recalibrated to preserve representativeness.

Can households access enough credit to smooth consumption?

Households with few savings or other liquid assets can also use credit to temporarily support consumption. Households’ current debt positions appear more favourable than in 2022. Real household debt stocks are lower, and the aggregate debt to income ratio has fallen from around 153% in 2022 Q1 to around 132% in 2025 Q4 (Chart E.2, left panel), primarily driven by a reduction in mortgage borrowing relative to income.

The availability of credit has improved since 2022, which should also help households to smooth consumption. The Bank’s Credit Conditions Survey (CCS) has shown improvements in lenders’ reported availability of both secured and unsecured credit, including credit card borrowing. And the latest expectations, reported for the three-month period to the end of February 2026, point towards a further improvement in credit availability (Chart E.2, diamonds in right panel). Taken together with the reduction in household indebtedness, this suggests that households may collectively have greater capacity than in 2022 to use borrowing to support consumption temporarily.

Chart E.2: Household debt has fallen relative to income since 2022 and the availability of credit has improved

Aggregate household debt to income ratio; ^(a) household credit availability ^(b)

Footnotes

• Sources: Bank of England, ONS and Bank calculations.
• (a) The measure shown is calculated as consumer credit and mortgage gross debt outstanding as a proportion of nominal household post-tax income. Household income is defined as post-tax income adjusted for changes in pension entitlements. This is further adjusted to exclude gross operating surplus and the effects of financial intermediation services indirectly measured, and to add back in interest paid. Mortgage interest payments before 2000 are adjusted for the effect of mortgage interest relief at source. The data are not seasonally adjusted. The final data point is for 2025 Q4.
• (b) The results are based on lenders’ own responses to the CCS. The question asked was ‘How has the availability of secured/unsecured credit provided to households changed?’ and respondents were asked to account for normal seasonal variations. The diamonds show expectations over the next three months based on the 2026 Q1 survey. To calculate aggregate results, each lender is assigned a score based on their response. Scores are positive for lenders reporting an increase in credit availability and negative for lenders reporting a reduction in credit availability. Lenders who report that credit conditions have changed ‘a lot’ are assigned twice the score of those who report that conditions have changed ‘a little’. These scores are then weighted by lenders’ market shares. The net percentage balances are calculated as the sum of the weighted scores across lenders and are scaled to lie between ±100.

How might recent rises in household interest rates affect consumption?

The increased cost of credit, due to recent rises in household interest rates, may affect the outlook for consumption. Higher energy prices have been accompanied by a rise in market-implied expectations for future Bank Rate, which has started to feed through into household borrowing rates (Section 1.3).

One way in which higher rates can lead to lower consumption is via a household debt channel of monetary policy (Foulis et al (2026)). This channel captures the negative effects of higher interest rates on house prices, which reduces the extent to which households can borrow by using housing as collateral, and also reduces mortgagor households’ disposable incomes due to higher mortgage payments (the cash-flow channel of monetary policy, Box A of the August 2025 Monetary Policy Report). As most mortgages are fixed rate, typically refinanced every two to five years, the effects of increases in mortgage rates feed through only gradually to consumption.

The rise in market interest rates is expected to weigh on household consumption relative to expectations at the time of the February Report. A microdata-based estimate of the household debt channel suggests that rises in mortgage rates preceding the onset of the Middle East conflict will continue to feed through to consumption as mortgagors refinance over time and will cumulatively reduce the level of consumption by 0.8% from the start of 2026 to end-2028 (Chart E.3, aqua line). More recent rises in mortgage rates mean that, based on the latest market-implied interest rates, aggregate consumption is now expected to fall by a further 0.6 percentage points as a result of this channel (the difference between the aqua and orange lines).

Chart E.3: The household debt channel is projected to weigh on consumption by more than expected at the time of the February Report

Projected impact of the household debt channel ^(a)

Footnotes

• Sources: Bank of England, ClearScore, FCA Product Sales Data (PSD), Foulis et al (2026), Money Dashboard, ONS and Bank calculations.
• (a) The data from January 2026 to December 2028 are monthly projections. The latest historical data are from the December 2025 PSD. The projections are informed by the Bank’s quoted mortgage rate data. The aqua line is consistent with the central projection in the February 2026 Report, and the orange line is consistent with Scenario A in the April 2026 Report. Conditional on the same market-implied path for Bank Rate as in Scenario A (Section 3.1), the consumption impacts would be similar to the orange line under Scenario B but could be somewhat higher under Scenario C, given that the weaker outlook for unemployment and house prices associated with that scenario could lead to slightly higher expected credit risk, which may be priced into mortgage rates. However, the differences between all three scenarios would be small relative to the impact of changes in the market-implied path for interest rates since the February 2026 Report.

Box F: How are global developments affecting UK non-energy import prices?

Movements in world export prices affect the cost of goods and services imported to the UK. Over the past year, two important geopolitical developments have influenced the prices charged by foreign exporters to the UK. Higher global trade tariffs are judged to have weighed a little on UK non-energy import price inflation owing to the effects of trade diversion. Any remaining disinflationary effects from higher tariffs are expected to be far outweighed, however, by the impact of the conflict in the Middle East. In addition to raising directly the cost of energy for UK households and businesses, the conflict is expected to increase UK non-energy import price inflation as foreign exporters pass on the higher cost of producing and transporting their goods due to higher energy costs (Section 1.1 and Box A).

Weak world export price inflation weighed slightly on UK non-energy import price inflation over 2025, consistent with some small disinflationary effects from higher trade tariffs. But the conflict in the Middle East is expected to raise UK non-energy import prices materially over coming quarters.

UK-weighted world export price inflation (excluding the direct effect of oil prices) was subdued during 2025, in part due to higher global trade tariffs having led to some trade diversion. The sterling ERI appreciated by 1.3% during that period compared with its average over 2024, and within that rose 3.2% against the dollar and fell 1.2% against the euro. Combined with the weakness in world export price inflation, that weighed on UK non-energy import price inflation (Chart F.1, left panel). The conflict in the Middle East is expected to push up significantly world export price inflation and consequently UK non-energy import price inflation this year, however, more than offsetting any remaining disinflationary effects from trade diversion.

Chart F.1: World export price inflation has been subdued, consistent with some small disinflationary effects from trade diversion

UK-weighted world export prices (excluding the direct effect of oil prices), UK non-energy import prices and the sterling ERI, ^(a) Chinese goods export values by destination ^(b)

Footnotes

• Sources: Bank of England, Bloomberg Finance L.P., China Customs – provided by CEIC, Eurostat, LSEG Workspace, ONS and Bank calculations.
• (a) UK-weighted world export prices are based on goods and services exports of 51 countries weighted according to their shares in UK imports, each measured in their domestic currency. The sample does not include any major oil exporters (except for the US). The final data point for the UK-weighted world export prices and UK non-energy import prices series is 2025 Q4. The final data point for the sterling exchange rate index series is 2026 Q1. Diamonds show Bank staff projections for UK-weighted world export prices excluding the direct impact of oil and UK non-energy import prices excluding fuel for 2026 Q1–Q2 for Scenarios A and B. The projection for Scenario C would be higher.
• (b) The bars show contributions to the change in the value of Chinese goods exports by destination since March 2025. ASEAN stands for the Association of Southeast Asian Nations and RoW stands for rest of the world. The data are shown in US dollars. The data are to March 2026.

Higher global trade tariffs appear to have led to some trade diversion.

Global trade tensions intensified last year, with the US increasing its effective tariff rate on a wide range of countries in March 2025. Bank staff estimate that the global effective tariff on imports to the US is currently around 12% and the effective tariff rate on US imports from the UK is around 9%. The effective tariff rate on US imports from China is around 24%. The slightly lower global tariff rate, relative to what was assumed at the time of the February Report, reflects the US administration’s decision to replace previously imposed tariffs with a new, temporary, uniform 10% tariff on all trade partners on 20 February 2026.

There is tentative evidence that higher global trade tariffs have led to some trade diversion, which has put downward pressure on world export price inflation as exporters have responded to lower demand from the US by attempting to shift some of their trade elsewhere, requiring a fall in the prices of those exports (Box C of the February 2025 Monetary Policy Report). The value of Chinese exports to the US has declined, as expected given the increase in US tariffs. There is limited evidence that those exports have been directly diverted to the UK or the European Union, however. While the right panel of Chart F.1 shows that the value of Chinese exports to these areas has risen, separate data suggest that the volume of those exports has not increased significantly above previous trends. This is consistent with Bank staff analysis which found limited evidence of significant shifts in export flows to the UK in previous episodes of higher tariffs (Box D of the August 2025 Monetary Policy Report).

There is some evidence of trade diversion to other regions. The value of Chinese exports to ASEAN and RoW has increased since March 2025 (Chart F.1, right panel). While data on Chinese export prices to ASEAN and the RoW are not available, Bank staff estimate that – based on data for Chinese import volumes to the US, euro area and the UK and the fact that Chinese export prices have overall fallen during this period – the price of Chinese exports to ASEAN and the RoW has fallen. That would be consistent with export volumes to those markets having risen.

Rather than trade diversion, the rise in Chinese exports to ASEAN and the rest of the world could be consistent with some rerouting of exports from China or changes to supply chains, whereby Chinese exports reach the US via other countries. Rerouting involves exporting goods originally destined for a market where they would face higher tariffs via a country facing lower tariffs, without a substantial change in where the goods are produced. The changes to trade patterns may also reflect a reorganisation of supply chains whereby instead of exporting the final goods intended for the ultimate destination, intermediate goods are exported to a country that faces lower tariffs and final goods are then exported from there (Box C of the February 2025 Monetary Policy Report). Rerouting or changes to supply chains would imply a smaller reduction in overall export demand from global trade tariffs, since these goods are continuing to reach the US. As such it would probably result in smaller disinflationary effects on global export prices compared with trade diversion.

Beyond the effects of trade diversion or possible rerouting, other factors may have contributed to a fall in Chinese export prices over the past year. The decline in Chinese export prices predates the imposition of higher trade tariffs and may reflect weak domestic demand in China as well as the depreciation of the renminbi effective exchange rate index over the first half of 2025.

Overall, trade diversion, alongside a broader decline in Chinese export prices, is likely to have put downward pressure on world export prices and subsequently UK import prices. The effects of US trade tariffs are expected to weigh on world export prices by a further 0.4% over the next three years.

The conflict in the Middle East is expected to raise world export price inflation materially, more than offsetting any remaining disinflationary effects from higher trade tariffs.

In addition to directly raising the cost of energy (Section 1.1), the conflict in the Middle East has raised the prices of some non-energy goods globally, largely through the indirect effects of higher energy costs. This has already started to feed through to higher world export price inflation. Global agricultural prices have risen by around 4.5% since the start of the conflict, largely owing to the direct effects of rising energy costs (Box A). The conflict has also pushed up prices of key inputs to fertiliser production, including urea, ammonia and sulphur, large volumes of which had passed through the Strait of Hormuz before the start of the conflict. Natural gas, the price of which has increased sharply, is also a key input into fertiliser production. Changes in fertiliser prices pass through to food prices with a lag given the length of harvest cycles. If the conflict were to persist and fertiliser prices to remain high, global food prices would increase further in the medium term.

Some costs of global goods transportation have also increased since the start of the conflict. European jet fuel prices have risen by 87% since then, consistent with around 40% of Europe’s jet fuel supply passing through the Strait of Hormuz. Container shipping costs have so far increased only very slightly (Chart F.2, left panel). This may partly reflect the fact that the Strait of Hormuz is not a major route for container shipping and some trade through the Red Sea had already been redirected to alternative routes, such as via the Cape of Good Hope, following Red Sea disruption in 2024 (May 2024 Monetary Policy Report). Survey evidence from the S&P Global Manufacturing PMIs suggests that input costs have increased, with the latest UK flash reading only slightly below its 2022 levels (Chart F.2, right panel). That recent increase could partly reflect the widespread nature of the shock, rather than the size of the price rise (Section 1.1).

The conflict is expected to have raised the level of world export prices by around 1% in 2026 Q1. World export price inflation is expected to peak in 2026 Q3 in Scenarios A and B, and in 2026 Q4 in Scenario C. Most of the rise in world export prices over the remainder of this year is judged to be the result of the conflict in the Middle East (Section 3).

Chart F.2: Global transport costs have risen only slightly following the conflict in the Middle East; input costs indices have risen by more

Shipping cost indices and survey indicators of global and UK manufacturers’ input costs ^{(a) (b)}

Footnotes

• Sources: Baltic Exchange, Freightos Baltic Index, J.P.Morgan, LSEG Workspace, Shanghai Shipping Exchange, S&P Global and Bank calculations.
• (a) ‘Global container transport’ represents the Freightos Baltic Container Index, a global measure of the cost of container transport. ‘Dry bulk cargo transport’ represents the Baltic Exchange Panamax Index, a measure of average prices paid for the transport of dry bulk cargo around the world on Panamax-sized carriers. ‘Container transport from China’ represents the China Containerised Freight Index, a measure of the cost of container transport from China. The data are monthly averages of daily data; latest data are to 22 April. The data are not seasonally adjusted.
• (b) A reading of above 50 indicates an increase on the previous month while a reading below 50 indicates a fall. The latest data point for the UK series is the flash estimate for April 2026; the latest data point for the Global series is the final estimate for March 2026.

Box G: How should monetary policy respond to an energy price shock?

An increase in global energy prices raises UK CPI inflation in the near term. That higher inflation can lead to second-round effects in domestic wage and price-setting, which may generate persistent inflationary pressures in the medium term. At the same time, an energy shock reduces UK households’ real incomes, which could weigh on demand. Monetary policy typically does not respond to the near-term effects of an energy shock on inflation but leans against any second-round effects to ensure that inflation returns to target in the medium term. Because energy shocks can push up inflation and weigh on activity, monetary policy should consider how best to manage a trade-off between the speed with which inflation is returned to target and the consideration that should be placed on the variability of output.

How does an increase in energy prices matter for monetary policy decisions?

The MPC is tasked with setting UK monetary policy to maintain price stability, defined by the 2% CPI inflation target which applies at all times. The MPC’s Remit also recognises, however, that inflation will sometimes depart from its target because of shocks and disturbances, and that ‘attempts to keep inflation at the inflation target in these circumstances may cause undesirable volatility in output due to the short term trade-offs involved’. A sharp increase in energy prices is a textbook example of such a shock, as it increases inflation while putting downward pressure on demand.

Energy prices are set on global markets and cannot be affected materially by UK monetary policy. The UK economy is a net energy importer, which means that an increase in global energy prices is an adverse terms of trade shock because one of the UK’s key imports has become more expensive. Monetary policy cannot offset this. Some combination of UK firms, households, and the government must absorb the resulting loss of real income. The task for monetary policy is to ensure that, as that adjustment happens, inflation returns sustainably to the 2% target in the medium term.

Energy prices affect UK inflation through several channels, with different potential implications for monetary policy (Table G.A). The direct effect from pass-through of changes in global energy prices to the motor fuel and utility prices faced by UK households is relatively quick. Energy price increases also have indirect effects on inflation because energy is an important input to the production of many goods and services. These indirect effects tend to come through somewhat more slowly (Box A).

Second-round effects can arise if the increase in energy prices generates persistently higher inflationary pressures in domestically set wages and prices (Box C). This could be driven by forward-looking increases in inflation expectations or by backward-looking real wage and profit resistance (Pill (2026)).

Meanwhile, the decline in real incomes due to the energy shock could lead households to reduce consumption, weighing on economic activity (Box E).

Monetary policy often looks through the direct effects of energy shocks on inflation.

Monetary policy usually looks through the direct effects of an energy shock on inflation. That is mainly because monetary policy works with transmission lags, which make it difficult to lean against direct effects (Bandera et al (2023)). Estimates in the literature vary, but many studies find that the peak impact of monetary policy on inflation comes after around 18 to 24 months (Christiano et al (1999), Romer and Romer (2004), Bernanke et al (2005) and Cloyne and Hürtgen (2016)). So, by the time the impact of tighter monetary policy would be at its peak, the direct effect of an energy shock has usually already dropped out of the annual inflation calculation or reversed. This means that a policy response large enough to offset direct effects would be likely to push inflation materially below target in the medium term, resulting in undesirable volatility in inflation and output.

But even if monetary policy lags were much shorter, it may not be optimal to respond to the direct effects of an energy shock on inflation. UK monetary policy cannot materially affect global energy prices, so offsetting the direct effect of an energy price shock would require pushing down domestic core inflation and wage inflation. This would create a larger output gap, an increase in unemployment and a decline in real wages (Broadbent (2021) and Tenreyro (2022)). Looking through the direct effects of an energy shock avoids such output volatility, as the MPC’s Remit suggests may be preferable.

Monetary policy may want to partially but not fully look through the indirect effects of an energy shock on inflation.

Monetary policy transmission lags can also make it difficult to respond to indirect effects. But because indirect effects tend to come through somewhat more slowly than direct effects, the argument is less clear cut. A policymaker who places weight on studies that find relatively short monetary policy lags (Cesa-Bianchi et al (2020) and Buda et al (2025)) may be inclined to lean against indirect effects. And, if energy cost increases propagate through supply chains with relatively long lags, an argument for leaning against them could become stronger. Protracted indirect effects following a large energy cost increase could keep inflation above target for some time, which could raise inflation expectations. By leaning against this, a tighter monetary policy stance could mitigate the development of second-round effects to some extent.

In response to an increase in energy prices, the prices of goods that are energy-intensive in their production should rise relative to the prices of less energy-intensive goods. This would encourage consumption to shift towards sectors where inputs are cheaper insofar as that is possible, reducing the economy-wide use of energy. In principle, relative prices could adjust by the prices of energy-intensive goods rising or by the prices of less energy-intensive goods falling. But when there are downward nominal rigidities that prevent prices or wages from falling, it is easier to achieve the relative price adjustment through price increases in energy-intensive sectors. This means that by looking through the indirect effects of energy shocks and letting core inflation rise, monetary policy can promote the efficient reallocation of resources across sectors and avoid any reductions in aggregate production and consumption due to an inefficient use of resources (Guerrieri et al (2021) and Rubbo (2023)).

Allowing core inflation to rise also means that many firms within each sector will have to adjust their prices, however, which would not be the case if monetary policy offsets the indirect effects of an energy shock. This can generate inefficient temporary distortions between the prices of goods with the same energy-intensity of production, because different firms reset prices and wages at different times (Aoki (2001), Woodford (2003) and Benigno (2004)). To strike a balance between promoting efficient relative price adjustments between sectors, but limiting inefficient price dispersion within sectors, monetary policy may want to partially but not fully look through indirect effects (Guerrieri et al (2023)).

Monetary policy must lean against second-round effects.

Monetary policy must lean against second-round effects to ensure that inflation returns to the 2% target sustainably. But the size of any second-round effects that emerge in response to an energy shock is uncertain. A small and short-lived energy shock might not generate any significant second-round effects. But the larger and the more persistent the shock is, the more likely such effects are to arise, for example because the shock pushes inflation above thresholds where additional persistence has historically taken hold (Box C). And second-round effects are more likely to arise if a sequence of shocks keeps inflation above target for an extended period, as was the case in 2020–23. The strength of second-round effects is also likely to depend on the extent of spare capacity in the labour market (Box D) and could be affected by people’s recent experience of inflation.

In practice, it is difficult to judge when and how strongly monetary policy should respond to second-round effects. Because monetary policy works with material transmission lags, it could be costly to wait for conclusive evidence of the strength of second-round effects, given that some of this evidence will only emerge with a delay as wage settlements – that are typically annual – are announced and consumer prices reset (Section 1.1). This means that, by the time policymakers can be certain about the strength of second-round effects, those effects may already have become entrenched.

When there is uncertainty about the strength of inflation persistence, it may be better to err on the side of setting policy as if inflation persistence will be significant (Söderström (2002)). By leaning against potential second-round effects to stop them from becoming entrenched, monetary policy can reduce the uncertainty about their size. Setting policy as if second-round effects will not emerge could run the risk of needing to tighten policy by more in the future to squeeze out entrenched inflation persistence, at a potentially larger cost to output.

Responding early to expected second-round effects also has potential costs, however. If second-round effects turn out smaller than anticipated, inflation may drop below the 2% target in the medium term as the energy shock fades and tight monetary policy overly suppresses demand.

Monetary policy makers have to balance these risks by monitoring indicators of potential second-round effects. They are required to judge continually whether sufficient evidence has accumulated to take action in order to prevent second-round effects from becoming entrenched (Monetary Policy Overview).

Monetary policy must consider how best to manage any trade-off between the speed with which inflation is returned to target and the consideration that should be placed on the variability of output.

Energy shocks can generate second-round effects that increase inflationary pressures in the medium term, but they also weigh on demand, which can result in more slack in the economy and an increase in unemployment. This means that, subject to returning inflation to the 2% target in the medium term, monetary policy faces a trade-off: all else equal, higher inflationary pressures would require a tighter monetary policy stance, while more slack could motivate a looser monetary policy stance.

The size and persistence of an energy shock, the strength of any resulting second-round effects on inflation, and the response of demand to the shock will determine the severity of the trade-off that monetary policy faces. The three scenarios set out in Section 3 illustrate that a larger or more persistent increase in energy prices is likely to lead to both larger second-round effects and greater slack, making the trade-off more acute and long-lasting (Chart 3.2). But there are also uncertainties about the impact of other factors on the emergence of second-round effects, such as the starting point for inflation, households’ and firms’ recent inflation experience, the extent of slack in the economy, and beliefs about how monetary policy makers will react.

How monetary policy makers choose to manage this trade-off depends on the weight they place on the variability of output relative to the speed at which inflation is returned to the target. Some policymakers may want to provide more support to output than others, at the cost of returning inflation to target somewhat more slowly. Policymakers’ preferences may also change over time, as economic developments can change the appropriate time over which inflation is returned to target. The weight placed on output stabilisation relative to inflation stabilisation is often captured in policy projections by the parameter ‘lambda’ (Carney (2017)): a lower lambda means that a policymaker is focused on returning inflation to target more quickly and is willing to tolerate more output variability to achieve this.

Varying lambda in Bank staff’s model-based projections illustrates that policymakers who broadly agree on the economic outlook may nevertheless prefer materially different policy stances if they have different views on how best to manage the trade-off. An illustrative exercise, shown in the swathes in Chart G.1, shows how Bank Rate could evolve in the three scenarios discussed in Section 3 depending on different policymaker preferences. The lower bound of each swathe traces a policy path for the scenario if the policymaker cares half as much about output stabilisation as they do about inflation’s deviation from the target, while the upper bound is the path for a policymaker who only cares about stabilising inflation. These exercises suggest policy paths that differ from the market curve and do not necessarily reflect policymakers’ assessment of the appropriate path of policy. Nevertheless, they illustrate that different preferences on how to manage trade-offs can lead to different policy paths: the swathes are between 50 basis points and 100 basis points wide across the scenarios. The swathe around Scenario C is wider than the swathes around Scenarios A and B, which reflects that the trade-off is more acute in the former than in the latter two scenarios.

Chart G.1: Policy decisions will be affected by policymakers’ views on the trade-off between the speed with which inflation returns to target and output volatility

Illustrative model-based policy projections ^(a)

Footnotes

• (a) Annex 1 provides additional detail on the definition of the illustrative model-based projections shown here and the equivalent paths for the output gap and inflation. These should not be interpreted as a prescription for how policy is likely to evolve. The solid lines are based on Bank staff’s standard calibration with λ = 0.25, while the swathes around the solid lies are based on λ = 0 and λ = 0.5.

Evidence on whether the economy is evolving in line with any particular scenario or not will emerge only gradually. This means that it may not be appropriate to set policy with only one preferred scenario in mind. For example, a policymaker who expects Scenario A to unfold but places some weight on the risk of large second-round effects if Scenario C materialises might want to lean against that risk by setting somewhat tighter policy than their reaction function for Scenario A alone would suggest. In contrast, a policymaker who places little to no weight on this risk may not want to insure against it, but would need to stand ready to adjust policy quickly if needed.

Should clear signs emerge that an adverse energy shock is leading to large second-round effects, policy would have to be tightened materially. Given the primacy of price stability in the MPC’s Remit, policymakers may choose to operate with a temporarily lower lambda, tolerating more output variability to ensure that inflation expectations remain anchored and inflation returns sustainably to the 2% target. A policymaker’s lambda may be state-dependent.