BoE holds interest rates in 6-3 vote as Iran conflict clouds inflation outlook

The Bank of England kept interest rates unchanged on Thursday as policymakers weighed easing domestic inflation against renewed uncertainty created by the conflict in the Middle East, where higher energy prices threaten to reignite price pressures.

The Monetary Policy Committee voted 6-3 to leave the benchmark Bank Rate at 3.75%, with three members supporting a quarter-point increase to 4%.

The outcome matched market expectations, although the split vote underscored growing divisions over how the central bank should respond to rising geopolitical risks.

Governor Andrew Bailey said the recent escalation in tensions involving Iran has made the near-term inflation outlook more difficult to predict, even as underlying domestic inflation continues to moderate.

Bailey warns energy prices remain a key risk

Bailey said the conflict in the Middle East has introduced fresh uncertainty into the inflation outlook through volatile oil and gas prices.

"The possibility of repeated resumptions of conflict, combined with lower than usual European gas stock levels and a fall in global refining output, mean that risks to energy prices lie to the upside," Bailey said.

At the same time, he argued that broader inflation trends in the UK remain encouraging.

"Set against that, the process of underlying disinflation that was intact prior to the conflict remains in train. That provides some tentative evidence that inherited inflation persistence may be weaker than had been presumed."

The governor was among the six policymakers who voted to keep interest rates unchanged.

Three members push for another rate increase

Not all policymakers agreed that holding rates was the appropriate course.

Chief Economist Huw Pill joined external members Megan Greene and Catherine L. Mann in voting for a 25-basis-point increase, arguing that inflation risks remain sufficiently elevated to justify tighter monetary policy.

The split decision reflects an increasingly difficult balancing act for the Bank.

While inflation has eased significantly from last year's highs, policymakers remain wary that another prolonged rise in energy prices could spill over into wages and broader consumer prices.

Iran conflict complicates inflation outlook

The Bank's latest policy statement acknowledged that the economic consequences of the renewed Middle East conflict remain highly uncertain.

Crude oil prices have climbed back above $90 a barrel this week as tensions between Washington and Tehran intensified, raising concerns that higher fuel costs could once again feed into inflation across advanced economies.

The MPC said recent developments have already pushed energy prices higher.

"In response to events in the Middle East, crude and refined energy prices have remained volatile and higher than pre-conflict. The impact of the energy shock on the UK economy remains uncertain."

While monetary policy cannot directly influence energy prices, the committee stressed that interest rate decisions will continue to focus on preventing temporary price shocks from becoming embedded in inflation expectations.

"Monetary policy cannot influence energy prices but is being set to ensure that the economic adjustment to them occurs in a way that achieves the 2% inflation target sustainably."

The committee added that the appropriate policy response would depend on how long elevated energy prices persist and how broadly they affect financial conditions, wages, and consumer prices.

Inflation easing but expected to rise again

Recent economic data have offered some reassurance.

Consumer price inflation slowed to 2.6% in June from 3.8% a year earlier, continuing its gradual decline toward the Bank's 2% target.

However, policymakers expect inflation to increase later this year as higher energy costs work their way through the economy.

"CPI inflation has fallen to 2.6% since the previous meeting, although it is expected to rise later this year as the effects of higher energy prices continue to pass through."

The committee acknowledged that prolonged energy price increases could eventually trigger second-round effects through wages and broader price-setting behaviour.

"The risk of material second-round effects in price and wage-setting, against which policy needs to lean, is greater the longer higher energy prices persist."

For now, however, policymakers said there is little evidence that such effects are emerging.

"There is little evidence so far to suggest such effects, and there have continued to be clear signs of underlying disinflation in recent data."

Markets still expect another hike this year

Financial markets had largely anticipated Thursday's decision.

Before the meeting, investors assigned more than a 90% probability to rates remaining unchanged, while still pricing in the possibility that borrowing costs could reach 4% before the end of the year if inflation proves more persistent.

Ed Hutchings, head of rates at Aviva Investors, said the divided vote illustrates how uncertain the policy outlook has become.

"Today's BoE decision to keep interest rates unchanged was fully expected, but going forward, it remains apparent that a lot of uncertainty amongst MPC members exists."

"This can be seen in both the voting pattern and the comments."

He added that although recent inflation and employment data have been encouraging, policymakers remain focused on future inflation risks rather than recent improvements.

"How this plays out is far from clear and although recent employment and inflation data has been of some comfort, investor attention and the Committee's focus is likely to be on risks around the outlook ahead, and particularly so from an inflation standpoint."

Government unveils cost-of-living measures

The Bank's decision came as Prime Minister Andy Burnham announced a package of measures aimed at easing pressure on households and businesses.

Among the measures is the removal of VAT on electricity bills from October, a move expected to reduce annual household energy costs by around £45 and lower headline inflation by roughly 0.1 percentage point.

Although inflation had been expected to move closer to the Bank's 2% target this year, the resurgence in oil prices following the renewed Iran conflict has complicated that outlook.

For now, policymakers appear willing to wait for additional evidence before tightening policy again, but Thursday's split vote suggests the debate over further interest rate increases is far from settled.