23 April 2026: The Iran War has shattered Britain’s hopes for 2026

In January, the Chancellor had every right to believe that things could only get better following a year in which she had tried to set the economy on the right track and failed. However, she was still trying to live in a bubble where her plans would not be disrupted by global events, which eventually came back to bite her.

Inflation was still too high, but the rate of increase was slowing rapidly, partly because Chancellor Rachel Reeves had mustered sufficient political nous to make targeted tweaks to key elements of price indexing at her second budget.

The prospect of interest rates falling faster than markets had anticipated meant we were enjoying a bit of a tailwind across the board. By the end of February, the UK 10-year gilt yield had fallen to its lowest level in more than a year.

Meanwhile, the long-stagnant UK housing market was showing signs of a fragile revival. With market expectations for interest rates falling, mortgage rates fell as well. By the end of February, we were seeing “best buy” rates of under 3.7% in some cases, with plenty of products available.

This all changed with the Iran war, but there were myriad reasons why Reeves was living in a fool's paradise.

The biggest slap in the face for the UK economy has been the expected impact of energy prices and broader shortages on inflation, and thus on interest rate expectations. We went from markets anticipating a couple of rate cuts to, for a brief moment, expecting as much as a full percentage-point rate hike.

Market histrionics have faded a little, but the Bank of England would rather not broach the subject of rate hikes at all if it can avoid it.

The doves on the MPC have put their collective foot closer to the economic brake, while the hawks are calling for more data before wanting to stamp down on it hard.

Yesterday’s inflation data showed the initial effect of the War in Iran, and now markets can see that the immediate future looks very different from what it was in January.

More inflation is likely in the works. Producer price inflation, the cost pressures on manufacturers and the like, rose sharply. And the longer the on-and-off-again war continues (the current big issue is the blockading of the Strait of Hormuz), the longer the disruption and the tighter the squeeze will be.

While the focus of Parliament is on “the Mandelson Affair”, Reeves will be only too aware that she may be facing a day of reckoning in two weeks when the nation returns to the polls for the biggest set of elections since the Labour Party swept to power in July 2024.

That said, although financial markets still expect one rate hike from the Bank of England this year, it’s by no means a sure thing. The challenge Central Banks face is that rising oil prices act like a tax. They can push prices up, but they also drain consumers’ spending power. Every pound spent on “needs” reduces what’s left for “wants”.

It’d be one thing if the jobs market were booming and employees were in short supply. That would raise the risk that confident workers, able to negotiate higher wages, would continue consuming, and, in turn, companies could pass costs on to these consumers. That poses the risk of “second-order” effects, whereby demand outstrips supply and drives prices higher.

The most obvious issue is the current state of the housing market. Mortgage costs have risen significantly, and while tracker loans (which typically move with the Bank of England rate) are now far more competitive than fixed rates, if you want your mortgage rate to begin with a 4, you need to take on more risk, which is not what homeowners are likely to do.

So the UK sector that has historically been extremely important to the “wealth effect” (the idea that you can spend because your household balance sheet looks so good) has gone from enjoying a tailwind at the start of the year to facing a very big headwind now.

The financial markets have apparently decided that the on-again, off-again nature of the conflict, which seems to have been distilled down to tit-for-tat actions in the Strait of Hormuz, is best left until a more permanent set of circumstances becomes evident.

The pound fell to a low of 1.3492 and closed at 1.3500 as traders await definitive action.

Democrats on Wednesday celebrated an election win in Virginia that could put them slightly ahead in the national redistricting competition President Donald Trump triggered to preserve his party's House majority in this year's midterms. Still, it will not be the final round.

Now that it's been approved by voters, the new Virginia map will have to clear additional legal hurdles. Yesterday, the State Attorney General’s office said it would immediately appeal a ruling earlier in the day from a judge in rural southern Virginia who ordered that the results of Tuesday’s vote not be certified.

Ultimately, the Virginia Supreme Court will decide whether Democratic lawmakers violated procedural rules by referring a constitutional amendment to the ballot authorising the creation of new U.S. House districts that could help Democrats win as many as four additional seats in the state. If so, that could invalidate the map voters narrowly approved on Tuesday.

While this should be an issue to be dealt with “in-house”, within the borders of the U.S., the very nature of Trump’s Presidency is that even obviously domestic issues are observed through the wider lens of global politics and economic fallout.

Trump is not a person who either looks at the big picture or has concerns about firefighting. He is likely to let November take care of itself even as his approval rating slips below 30%.

He insists that America is winning the war in the Gulf simply because he believes that the more he says it, the more it becomes true. Events in the Strait of Hormuz yesterday show that Iran has at least an equal say, if not the upper hand.

Trying to Bomb Tehran into submission has only made the Regime more determined, and now that the bombing has (temporarily) stopped, many Iranians see their country more positively.

Trump’s view of regime change is that killing the Supreme Leader and placing a new person at the head of the regime means that the regime’s ideals have changed. Furthermore, the fact that the new Supreme Leader shares the same name as his predecessor is unlikely to bring about change, particularly as the new leader is still mourning the death of his father at the hands of America and Israel.

It also doesn’t help that the Supreme Leader is still named Khamenei.

Meanwhile, the “Kevin Warsh saga” continues. Confirmation hearings for Federal Reserve chairs are usually staid, rubber-stamp affairs. Not this one.

Democrats and one key Republican from the Senate Banking Committee repeatedly attacked President Donald Trump, his pick for Fed chair, Kevin Warsh, and, at times, both, in a fiery hearing that included questions about an undisclosed $100 million in investments and accusations of White House pressure.

Democratic Sen. Elizabeth Warren called Warsh “uniquely ill-suited” for the job, accusing him of acting as a “glove puppet” for Trump, who has said he would only choose a Fed chair who will cut rates. Warsh strongly defended his independence from politics, trying to fend off tough questions about his financial disclosures and recent reversal on setting interest rates.

Yet again, the market is shown that “when America sneezes, the world catches a cold”.

Traders remain determined to buy dollars even with only the slightest inclination toward greater risk aversion. Yesterday, the dollar index rallied to a high of 98.64 and closed at 98.62.

Economic data.

That used to be the major driver of financial markets. Although that train has (temporarily) left the station, thankfully, it is still waiting at the platform in the Eurozone. Members of the European Central Bank’s Governing Council are still largely driven by inflation, no matter what its source is.

Christine Lagarde has a completely different view of the Eurozone economy from that of UK Chancellor Rachel Reeves. Lagarde always qualifies her remarks with the caveat that the Central Bank must be reactive to global events as it tackles the unique challenges that they create for the region.

However, one criticism that can be levelled at the ECB is its constant use of the “one size fits all” mantra, which is as outmoded today as it always has been.

If Rachel Reeves wants to move closer to Europe, she may be wise to face up to the issues that are facing the economy rather than looking to place the blame elsewhere.

Germany's Economy Ministry cut its growth forecasts for 2026 and 2027 and raised its inflation projections on Wednesday, as the war in Iran drives up oil and gas prices.

In what may be a refreshing dose of realism, the government now expects 0.5% growth for 2026, down from an earlier projection of 1.0%, and has also cut its 2027 growth outlook to 0.9% from 1.3%, confirming a Reuters report last week.

"The German economy is on a modest recovery path, but the headwinds have intensified," Economy Minister Katherina Reiche said. "External geopolitical shocks are once again holding back the economic recovery expected for this year."

The war in Iran is driving up energy and raw material prices, the minister said, placing financial strain on private households and increasing costs for Germany's economy.

The ministry now expects inflation to accelerate to 2.7% this year and 2.8% in 2027, up from 2.2% last year.

Further economic developments will depend largely on how the conflict in the Middle East evolves and are subject to considerable uncertainty, the minister said.

In addition to the war in Iran, international trade faces headwinds from protectionist measures and economic fragmentation, which hinder Germany's export-oriented economy from leveraging foreign trade to boost growth.

Exports are not expected to rise year on year until 2027, when they are forecast to increase by 1.3%.

Imports are expected to grow faster, rising by 1.8% in 2027, thereby narrowing Germany's trade surplus.

Europe's largest economy has been struggling since the COVID-19 pandemic to regain momentum. Heightened competition from China and higher energy costs pose significant challenges to its export-driven economic model.

Reiche said she will travel to China in May to discuss key issues.

The Euro lost ground again yesterday against the dollar as traders still try to decide just how hawkish G7 Central Banks will be at meetings scheduled for next week. The ECB is likely to call for more data before deciding whether the current bout of inflation will persist. The euro fell to a low of 1.1703 and closed at 1.1705.

Have a great day!