BOE holds rates, signals hikes as Middle East war lifts inflation

The Bank of England (BoE) held its benchmark interest rate steady on Thursday but signaled a more hawkish stance as rising energy prices linked to the Middle East conflict threaten to push inflation higher.

The nine-member Monetary Policy Committee (MPC) voted unanimously to keep rates unchanged at 3.75%, marking its first unanimous decision in over four years.

The outcome came despite expectations among economists of a split vote, underscoring the heightened uncertainty facing policymakers.

BOE shifts tone as inflation risks intensify

The central bank indicated a clear shift in tone, warning that the inflation outlook has worsened due to geopolitical developments affecting global energy markets.

Governor Andrew Bailey emphasized the need for vigilance in managing inflation risks.

“We have held interest rates at 3.75% as we assess how events unfold,” Bailey said. “Whatever happens, our job is make sure inflation gets back to its 2% target.”

He also warned that policymakers must be prepared to respond if energy-driven inflation becomes more persistent.

Bailey noted that rising oil and gas prices are already feeding through to the UK economy via higher petrol costs, with household energy bills expected to increase later this year if the conflict continues.

The BoE now expects inflation to accelerate to around 3.5% in the near term, higher than previous forecasts, reflecting the impact of elevated energy prices.

Markets price in rate hikes as outlook turns hawkish

Financial markets reacted swiftly to the BoE’s more hawkish stance.

Traders ramped up expectations for tighter monetary policy, fully pricing in at least two quarter-point rate hikes this year and increasing the likelihood of a third.

Government bond yields surged, with two-year gilt yields rising sharply, while the British pound strengthened against the dollar.

The MPC also dropped earlier guidance suggesting that rates were “likely to be reduced further,” reinforcing the shift away from expectations of near-term easing.

Policymakers signaled that further action could be necessary if inflation pressures persist.

Internal discussions within the MPC highlighted a range of views.

Catherine Mann suggested that a rate hike could be required to prevent inflation from becoming entrenched, while Chief Economist Huw Pill said he was “ready to act” if risks intensified.

At the same time, some policymakers remained cautious. Alan Taylor noted that there remains “a high bar to hiking” given the uncertainty surrounding energy prices.

Economic weakness complicates policy path

The BoE’s policy decision comes against a backdrop of a weakening domestic economy, adding complexity to its inflation-fighting mandate.

Recent data showed wage growth slowing to its lowest pace since late 2020, while broader economic growth remains subdued.

The central bank acknowledged that the labor market has softened in recent quarters, even as it continues to monitor inflation risks.

Officials stressed that monetary policy cannot directly influence global energy prices, but highlighted concerns about so-called second-round effects, where higher costs feed into wages and broader price pressures.

The current situation has drawn comparisons to the 2022 energy shock following Russia’s invasion of Ukraine, though inflation remains far below the peak of 11.1% reached at that time.

Economists noted that the BoE is navigating a delicate balance between controlling inflation and supporting growth.

With energy prices rising and geopolitical risks persisting, the BoE appears set to maintain a cautious but increasingly hawkish stance as it assesses the evolving economic impact of the conflict.