The Bank of England's monetary policy committee voted to hold interest rates at 3.75% on Thursday, with the Middle East conflict seen as the main obstacle to a reduction. Senior UK central bankers believe the war makes the difference between a benign inflation outlook and one where prices rise again.
Domestic inflation pressures absent
Underlying inflationary pressures are almost entirely absent in the domestic economy, the MPC stated. Prices are stable and would be rising steadily at the 2% target without the war. However, Threadneedle Street officials worry that companies might raise retail prices by taking advantage of consumer expectations that war has increased production costs. They also fear workers may seek major wage increases if they anticipate another inflation spike.
No second-round effects yet
So far, no such trends have emerged. Supermarkets have kept food inflation low, and services companies have restricted price increases this year. The Bank's quarterly review noted: "So far, there are few signs of second-round effects. But there is not enough evidence yet to rule out this risk, and the MPC will continue to monitor evidence closely." Annual wage increases in the private sector were 2.8% in the second quarter, expected to rise to 3% in the third quarter – a level the Bank is comfortable with. Official data also does not show companies capitalising on rising prices across manufacturing, construction, or services.
MPC split and labour market focus
Three MPC members voted to increase rates, arguing that once prices rise again, workers and firms will react, embedding inflationary pressures even if the war ends. The majority focused on the labour market, noting rising unemployment and a sharp fall in vacancies over three years. Financial markets have already raised mortgage and commercial lending rates, tightening conditions without a Bank move.
Inflation forecasts and economic impact
The Bank's forecasters expect inflation to peak at 3.2% next spring, but could reach 4.1% if the war persists and Brent crude stays above $100 a barrel. The National Institute of Economic and Social Research said the UK has lost £28bn in growth this year due to the conflict. The Bank warned it may need to raise rates if the war continues, potentially worsening the impact on businesses, consumers, and mortgage borrowers.
