British government bonds and the pound came under heavy pressure on Monday after a sharp surge in global oil prices triggered concerns about rising inflation and the possibility of higher

interest rates in the United Kingdom.

Oil prices jumped by roughly 25%, driven by escalating conflict in the Middle East, sending shockwaves through financial markets. The spike has raised fears that energy costs could fuel another wave of inflation in the UK, forcing the Bank of England to reconsider its monetary policy path.

As a result, investors quickly reassessed expectations for interest rates. Markets that had previously anticipated rate cuts later this year are now pricing in the possibility of a rate hike before the end of 2026.

UK bonds hit hard

The selloff was most visible in the UK gilt market. Two-year gilt yields climbed as much as 37 basis points to 4.239% during early trading, marking one of the sharpest intraday increases since the market turmoil that followed former Prime Minister Liz Truss’ fiscal plans in September 2022.

By early afternoon in London, the two-year yield remained 21 basis points higher, still pointing toward one of the steepest daily moves in recent years. Bond yields rise when prices fall.

Longer-dated debt also weakened, with five-year yields up 14 basis points and 10-year yields rising by 10 basis points. UK bonds underperformed comparable government debt in Germany, France, and the United States, highlighting investor concerns about Britain’s vulnerability to energy-driven inflation.

Sterling drops against the dollar

The British pound also weakened sharply during the session, briefly heading for its **largest daily fall against the U.S. dollar in over a month**. The currency later recovered some ground but was still down about 0.3% by the afternoon.

Analysts say the UK’s relatively fragile public finances make the country more exposed to energy price shocks compared with other major European economies.

Markets flip from rate cuts to hikes

The oil-driven inflation risk has dramatically shifted market expectations for UK monetary policy.

Investors have completely priced out any Bank of England rate cuts for 2026, with derivatives markets now assigning roughly a 57% chance of a quarter-point rate increase by December.

Hal Cook, senior investment analyst at Hargreaves Lansdown, said higher oil prices could push inflation above earlier forecasts.

“Sharp increases in oil prices will likely push UK inflation higher in the short term,” Cook noted. “Many investors had positioned for interest-rate cuts this year, which would have boosted gilt returns. With cuts now looking unlikely, markets are rapidly repricing.”

Pressure on government finances

The surge in energy costs could also complicate the government’s fiscal plans.

Prime Minister Keir Starmer said on Sunday that supporting working households remained a top priority, comments that some investors interpreted as a signal that the government could introduce new measures to help families cope with rising energy bills.

However, such support could further strain the country’s finances. According to Lloyds Bank, a rise in inflation of about 2.5 percentage points could eliminate the government’s £23.6 billion fiscal buffer, even before factoring in additional cost-of-living support or slower economic growth caused by higher energy prices.

Starmer added that the current state-regulated household energy price cap is expected to remain in place until June, offering some reassurance to consumers.

Meanwhile, Chancellor Rachel Reeves is expected to provide an update in Parliament on the government’s economic response to the Middle East crisis.

Some investors see opportunity

Despite the sharp market reaction, some asset managers believe the selloff in UK bonds may be overdone.

David Roberts, head of fixed income at Nedgroup Investments, said his firm has already increased its exposure to gilts in a global bond fund from 6% to 9%.

Roberts argued that central banks may look past the shock if oil prices stabilize.

“If this turns out to be a short-term spike and oil prices settle over the next six to eight weeks, a rate hike from the Bank of England looks unlikely,” he said. “In that scenario, not only the BoE but also the European Central Bank and the Federal Reserve may treat it as a temporary shock.”

Global response in focus

Finance ministers from the Group of Seven (G7) countries were scheduled to meet Monday to discuss the potential release of emergency oil reserves in an effort to stabilize energy markets and ease pressure on the global economy.

For now, however, the combination of soaring oil prices, inflation concerns, and fragile public finances has left UK markets on edge — with both gilts and the pound feeling the strain.