Bank of England hold interest rate at 3.75% as Iran war shakes outlook
The Bank of England (BOE) is in London, England, on Monday, December 15, 2025.
Bloomberg | Bloomberg | Getty Images
The Bank of England decided to keep interest rates at 3.75% on Thursday, as economists widely expected, as the Iran war continues to pose a dilemma for policymakers.
The central bank was expected to monitor interest rates as it waits to see how the collapse in energy prices caused by the Iran war and the simultaneous reignition of inflationary pressures in the UK will play out in the economy.
The Bank’s Monetary Policy Committee voted 8-1 to keep the benchmark interest rate, known as the “Bank Rate,” at 3.75%, with notoriously hawkish BOE Chief Economist Huw Pill the only dissenter to vote for the 25 basis point increase.
Following the decision, the British pound rose by 0.4% against the dollar to $1.3473. Borrowing costs fell as the benchmark 10-year yield fell 6 basis points to 5.014%.
In a summary of Thursday’s decision-making process, the BOE said it expects the war in the Middle East to continue to raise energy and fuel costs and that its ability to ease those pressures through monetary policy is limited.
“The conflict in the Middle East means that the expectations for global energy prices are extremely uncertain. Monetary policy cannot affect energy prices, but will be determined to ensure that economic regulations for them are achieved in a way that sustainably achieves the 2% inflation target,” the report said.
“The policy stance required to achieve this will depend on the size of the shock, its duration and how it spreads through the economy.”
More price increases coming
The BOE said Thursday that inflation “will likely be higher later this year as the effects of higher energy prices wear off” and that it is wary of second-round effects on the economy, such as workers demanding higher wages in the face of higher living costs, potentially fueling further inflation.
“There is a risk of material second-round effects that policy must rely on in setting prices and wages. But the labor market continues to ease and a weakening economy could contain inflationary pressures. Financial conditions have tightened since the conflict began, which will help reduce inflation over time,” the BOE said.
“Taking into account all risks to the economic outlook, the Committee is of the opinion that it is appropriate to keep the Bank Interest rate constant at this meeting.”
However, the BOE included three scenarios reflecting the possible outlook for the UK economy, depending on the size and duration of increases in energy prices and the severity of the second-round effects that may occur.
In the best-case scenario, inflation is expected to rise to 3.5 percent by the end of this year and then decline. In the most severe case, inflation could rise “much more sharply” and peak at 6.2 percent in early 2027, remaining high above the bank’s 2 percent inflation target until 2029.
In this worst-case scenario, the BOE said the Bank Rate would rise to around 5.25% in 2027. Although this would reduce the inflation peak expected in this scenario, “it would come at the expense of a larger output gap and increase the risk of recession.”
Lieutenant governor Clare Lombardelli said that although this was not seen as a “central situation” it was “reasonable and will require policy to respond more strongly to inflationary pressures”.
The Bank of England (BOE) is in London, England, on Monday, December 16, 2024.
Jason Alden | Bloomberg | Getty Images
According to the statement, the bank is ready to respond with monetary policy if necessary, but David Rees, Schröders’ head of global economics, said the bar for interest rate hikes “remains high”.
“The risk of persistently high inflation and speculation about political change after local elections have pushed gold yields to an almost 20-year high,” he said in emailed comments.
“As some labor market recession is likely to emerge and growth is likely to weaken if disruption continues, we doubt the Bank will tighten unless economic activity remains strong enough to absorb this,” he said.
