The Bank of England has left UK interest rates unchanged at 3.75%, with policymakers warning that a further escalation of the Iran war could drive inflation above 4% next year. The monetary policy committee voted six to three to hold the key base rate, against a backdrop of rising global energy prices.
Under an “adverse scenario” involving a prolonged conflict and oil prices remaining above $100 a barrel, the Bank said inflation could peak at 4.5% by mid-2027. However, Governor Andrew Bailey dismissed suggestions that Threadneedle Street was moving closer to a rate rise, noting inflationary pressures had not become entrenched and the growth outlook remained weak. “Please do not leave this room thinking that the Bank of England is edging towards a hike,” he said.
Official figures show UK inflation fell more than expected to 2.6% in June, down from a peak of 3.8%, and had been on course to approach 2% before the war. The Bank said a looser labour market and higher borrowing costs would subdue inflation over time, with pre-conflict conditions more benign than before the Covid pandemic or Russia’s invasion of Ukraine.
The decision is expected to bolster Prime Minister Andy Burnham’s efforts to ease the cost of living. His recently announced package includes removing VAT from electricity bills, cutting them by an average of £45 a year from October, and a £2 cap on bus fares in England. The Bank estimates these measures will reduce headline inflation by 0.1 percentage point.
Three MPC members – Catherine Mann, Megan Greene and Huw Pill – dissented, voting to raise rates immediately to 4%. Financial markets had priced in a greater than 90% probability of a hold, with investors expecting a rise to 4% before the year ends. The news follows the US Federal Reserve’s decision to hold rates on Wednesday, while Brent crude traded just below $90 a barrel after briefly exceeding $100 last week.
Under the Bank’s central forecast, which assumes oil falls to about $71 a barrel, inflation is still expected to peak around 3.2% later this year. A milder conflict scenario would see it peak near 3% before falling, enabling rate cuts. Capital Economics’ Paul Dales said: “Much depends on what happens to energy prices and whether or not that leads to the second-round inflation effects.”
