Inflation could surge past 6pc if the war in the Middle East triggers a prolonged energy price shock, the Bank of England has warned.

Policymakers voted to keep borrowing costs on hold at 3.75pc even as Andrew Bailey, the Bank’s Governor, warned of further price rises.

The Bank warned that under its worst-case scenario—a drawn-out war leading to $100 a barrel oil into 2028—inflation would peak at 6.2pc

This would require a “forceful” increase in borrowing costs that could take interest rates above 5pc.

However, Mr Bailey sought to allay fears of imminent rate hikes, adding that policymakers were also concerned about a weaker economy.

Unemployment is now set to climb above two million for the first time in more than a decade.

Mr Bailey said modest price rises that did not trigger higher wage demands would allow the Bank to proceed “without further increasing rates”.

His comments helped send the FTSE 100 up as much as 1.7pc and pushed down the cost of government borrowing, with the yield on two-year UK gilts dropping by 0.1 percentage points to 4.45pc.

Brent crude oil prices briefly reached a four-year high amid uncertainty on an Iran deal before dropping back.

Sanjay Raja, chief UK economist at Deutsche Bank, said the Bank of England had “bought itself time” by holding interest rates, but said the next move was more likely to be up than down.

He said: “Today’s ‘active hold’ kicks the can of a rate hike down the road – at least to July, in our view. The longer the energy shock lasts, the higher the likelihood of rate hikes. And the more the Bank staff’s short-term projections are tested, the harder it will be for some on the committee to remain on the sidelines. Given elevated geopolitical uncertainty, risks of multiple rate hikes can no longer be discounted.”

Policymakers said living standards were already falling, dealing a blow to Sir Keir Starmer’s pledge to raise them faster than any other G7 economy.

Mr Bailey said some of the “largest” price rises would be seen at the supermarket as the Bank warned of a renewed squeeze on living standards.

Food inflation is predicted to hit 7pc by the end of the year because of higher fertiliser costs. Some experts warn that food prices could see double-digit inflation by December.  

It estimated the conflict would add £80 to monthly mortgage payments and push typical gas and electricity bills towards £2,000 by the summer.  

The Bank set out three scenarios for how the Iran war could affect the economy in its latest Monetary Policy Report.

If the conflict ends soon and oil prices fall back below $80 a barrel by the start of next year, the Bank predicted inflation would peak at 3.6pc, up from 3.3pc in March. Unemployment would rise above two million by the start of 2027 and growth would also likely to be materially weaker at 0.8pc this year and 1pc in 2027.

However, it warned that continued disruption keeping oil prices above $100 a barrel until the start of 2028 would push inflation above 6pc within a year, while unemployment would peak at 2.1 million by the end of 2027.

Mr Bailey described current market predictions for a quick drop in oil and gas prices if the conflict is resolved as “too optimistic” as he warned that restoring energy supplies would take time, even if the conflict was resolved quickly.

However, he added that “it would be a mistake to wait” for sharper pay rises to materialise before hiking rates.

Policymakers signalled that a scenario where inflation peaks near 4pc and oil and gas prices fall back more slowly was more plausible.

Under this scenario, Mr Bailey said it might still be possible to keep interest rates on hold to steer inflation back to target.

“It is not the case that we’re giving some sort of slightly clandestine message that interest rates are going to go up,” he said.

Deputy Governor Clare Lombardelli said the Bank would continue to analyse households’ response to higher prices, including through inflation expectations, pay deals, and consumers’ willingness to dip into their savings to cope with higher prices.

Huw Pill, the Bank’s chief economist, called for an immediate rate hike to 4pc to keep inflation under control in the 8-1 split vote.

He warned that there was a significant risk that inflation remained “persistent” and said a rate hike now would reduce the likelihood of price rises becoming entrenched in the economy.