The Bank of England has warned that a prolonged energy shock from the Middle East war could drive up inflation, opening the door to higher interest rates and deepening a brutal sell-off in the gilt market. The Monetary Policy Committee voted unanimously to hold interest rates at 3.75 per cent at its first meeting since the US and Israel attacked Iran last month.

In a sign of how radically the war has reshaped the challenge facing rate-setters, the MPC said that a severe energy shock could feed into wages and prices across the economy. Two-year gilts were hit particularly hard, with yields soaring 0.34 percentage points to 4.45 per cent, putting UK government bonds on track for their worst day since the war started.

The MPC's assessment prompted traders to increase their bets on interest rate hikes this year, with markets now pricing in at least two quarter-point rises and a small chance of a third. The energy shock has raised the stakes for the MPC, which must now balance the renewed risk of inflation with lacklustre economic growth.