The Bank of England is in no rush to raise interest rates while the outcome of the Iran war remains uncertain and the UK’s growth rate stays weak, its governor, Andrew Bailey, has said. In a signal that borrowing costs will remain at 3.75% at least during the summer, Bailey said it was tolerable for inflation to stay above the Bank’s 2% target during the current crisis.
“Given the context of softness in the real economy and uncertainty around the scale and duration of the shock, tolerating temporarily above-target inflation to provide some support for the real economy is an appropriate way to approach the trade-off [between inflation and activity],” Bailey said. “But that tolerance would weaken if signs of second-round effects begin to emerge.”
At the start of the year, financial markets had expected the Bank to cut interest rates twice this year to 3.25%. Since the Iran war began, the situation has reversed, and now a rise of 0.25 percentage points to 4% before December is forecast. Speaking at a conference in Reykjavik, Bailey said the economic situation had deteriorated since the start of the bombing of Iran by the US and Israel.
Bailey said one reason the Bank was prepared to wait was that borrowing costs had risen for homeowners and businesses without the central bank needing to adjust interest rates. He noted that mortgage costs had increased since hostilities broke out as lenders reversed their expectations of rate cuts, dampening the housing market. “We have, in effect, tightened policy in my view. I was quite clear that I thought we probably would cut rates once or twice this year. That’s off the table,” he said.
Rising bond rates have also increased the cost of financing the government’s £3tn debt load, although Bailey said that in recent weeks this trend had eased. He said the central bank was now better prepared to assess the likely impact of rising energy costs on the economy and inflation, after adopting scenario planning, and was unlikely to allow a repeat of the previous inflation increase without taking swift action.
