Since the initial attacks on Iran and the entirely predictable closure of the Strait of Hormuz, global energy prices have increased substantially. The UK last found itself exposed to sharply higher gas prices following the Russian invasion of Ukraine in 2022, which led to 10%+ inflation rates and elevated interest rates for a sustained period. There have been moves to lessen the impact of similar events on UK retail energy prices, but how exposed is the UK to the military action in the Middle East?
To put it simply, the UK remains exposed to moves in wholesale gas prices, but the structure of the UK energy market means the impact is delayed and smoothed rather than immediate and directly proportionate.
Starting with the electricity mix, the UK has made real progress. Roughly half of electricity generation now comes from renewables, and gas is only around a third of the mix. While that sounds reassuring, the key point is that gas still sets the price in the wholesale electricity market most of the time. It is the marginal fuel, so even if renewables are generating a large share of the power, the price households ultimately pay for electricity is still heavily influenced by gas.
That means higher gas prices feed through in two ways. First, directly into retail gas bills, and second, indirectly into electricity prices via the wholesale power market.
Then there is the question of supply and storage. The UK is not short of gas in a physical sense. Supplies are diverse, with a combination of domestic production, pipeline imports from Norway, liquified natural gas (LNG), and some storage. But storage capacity is relatively limited compared with continental Europe (3.2bn m3 compared to 100bn m3), and LNG is priced in a global market. So, when global gas prices move, the UK cannot fully insulate itself. Storage does help smooth short-term volatility, but it will not eliminate the impact of a sustained price rise.
Where things get more interesting is the price cap, because this is what really determines how quickly wholesale moves hit households. Ofgem’s methodology is designed to avoid exactly the kind of sudden bill shock seen in 2022. It uses a rolling observation window and effectively assumes suppliers hedge over a 12-month period. The result is that retail prices adjust with a lag and are smoothed over time. So, if wholesale gas futures spike today, it needs to feed through the observation window and then into the next quarterly cap.
Therefore, the impact becomes a question of persistence. If wholesale gas prices stay elevated through the next few months, then it will start to feed into the July and October caps. If the spike fades quickly, the impact on household bills could be minimal.
What does that mean for CPI inflation, assuming we are thinking only about the impact of wholesale gas prices and not the effect of higher energy and oil prices on almost everything? In the very near term, probably not much. The lagged nature of the cap means the current spike in wholesale gas prices will have little immediate impact on headline inflation (although elevated petrol prices will have an immediate effect).
If higher wholesale gas prices persist, energy will start to push CPI higher again later in 2026. At current levels, the magnitude is unlikely to be dramatic; we are not looking at a repeat of the 2022 shock. A reasonable central case is that energy adds a few tenths of a percentage point to inflation, but the direction of travel would clearly be upwards relative to where forecasts were heading.
However, there are also second-round effects to consider. Higher energy costs squeeze household real incomes and raise input costs for businesses. That can slow growth while keeping inflation a little stickier. The effect is therefore stagflationary.
Which brings us to interest rates. The Bank of England is already in a position where it is balancing falling inflation against a softening economy. A sustained rise in energy prices complicates that picture.
Historically, the Bank may have looked through an energy-driven rise in inflation, particularly if it is judged to be temporary. Central banks generally focus on underlying domestically generated inflation rather than volatile energy components. In this way, one spike in gas prices does not automatically change the policy path.
However, given that the UK is recovering from a higher inflation environment, policymakers are likely to be less tolerant of the energy price spike. Higher energy prices could begin to feed into expectations, wage demands or service inflation more quickly than during normal times. Even with under three weeks since the conflict started, rate cuts are likely to be delayed. The direction of travel could still be towards lower rates, but the timing will shift.
The UK economy is in a different place than during the initial Russian attacks on Ukraine. Unemployment is over 5%, vacancies are falling, growth is slow, and the household savings rate is already above long-term averages. Higher energy prices could act as a brake on growth rather than lead to a feared wage price spiral.
The gilt market has already started to reflect this balancing act. Yields have risen due to the inflation implications of higher energy prices, pricing out expected interest rate cuts but not pricing in much in the way of interest rate hikes. This is an acknowledgement that monetary policymakers are somewhat constrained in their response due to the weak economic position.
The most likely outcome is that this is a temporary energy shock that adds a small bump to inflation and slows the pace of monetary easing. In that world, the Bank of England still cuts rates, but perhaps later and more cautiously than previously expected.
The more severe scenario, where gas prices remain elevated for a prolonged period, would be more problematic. That would push inflation higher for longer and could materially delay rate cuts. But for now, the structure of the UK energy market and the price cap mechanism mean the impact is real, but measured rather than immediate.
If you’d like to learn more about our macroeconomic and interest rate forecasting services, please contact us on info@arlingclose.com.
19/03/2026
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