Bank of England holds interest rates at 3.75% as inflation fears mount | Interest rates

The Bank of England left interest rates unchanged in the UK, warning that further escalation of the Iran war could push inflation above 4 percent next year and increase cost-of-living pressure on households.

Against a volatile backdrop in the Middle East conflict, the Bank’s monetary policy committee (MPC) voted by three votes to six to keep the key base rate at 3.75%.

As Donald Trump’s renewed attacks on Iran boost global energy prices, the Bank said a “negative scenario” involving a protracted war and oil prices remaining above $100 a barrel could push UK inflation to a peak of 4.5% in mid-2027.

But on a day of fresh US strikes in the widening conflict, the bank’s governor, Andrew Bailey, played down suggestions among City traders that Threadneedle Street was getting closer to a rate hike.

At the press conference following the decision, he said there was little sign of inflationary pressures strengthening as the growth outlook for the UK economy remained weak.

“Please do not leave this room thinking the Bank of England is heading for a crisis. [interest rate] Take a walk, because frankly there is nothing in what I said and I don’t think any of us said it along those lines,” Bailey said.

Inflation in the UK fell more than expected in June, falling to 2.6% from last year’s peak of 3.8%, official figures showed. It was on track to decline close to 2 percent before the start of the Iran war.

The bank said a looser labor market and higher borrowing costs for households and businesses compared with before the war would reduce inflation over time. He added that conditions before the conflict were more “benign” than before previous global shocks, including the Covid pandemic and Russia’s invasion of Ukraine in 2022.

The decision to leave interest rates unchanged is expected to give a boost to Andy Burnham’s bid to reduce the cost of living after he announced a comprehensive support package for households in his first week as prime minister.

Under their plans, electricity bills in Great Britain will be cut by an average of £45 a year from October by removing VAT. The bank said it expected the policy, along with a £2 cap on bus fares in England, to reduce the headline inflation rate by 0.1 percentage points.

But the MPC said it was “ready to act as necessary” to prevent inflationary pressures from taking root.

Stubbornly highlighting the risk of high inflation, the MPC’s external economist Catherine Mann joined committee members Megan Greene and Huw Pill in opposing the panel’s majority in voting to raise rates immediately to 4%.

Greene, another outside member, and Pill, the Bank’s chief economist, were previously unable to vote when pushing for a quarter-point increase at the previous MPC meeting due to concerns about inflation.

Financial markets had priced in an over 90% chance of Threadneedle Street keeping borrowing costs steady, but the possibility of an upside was out. Investors expect borrowing costs to rise to 4% before the end of the year.

The news comes after the Federal Reserve left borrowing costs unchanged on Wednesday and its new chairman, Kevin Warsh, angered some investors who worry about whether the central bank is ready to combat high inflation; This led to U.S. government borrowing costs rising to the highest level since 2007.

Brent crude, the international benchmark for oil, briefly rose above $100 a barrel last week amid fears that violence in the Middle East could shatter the world economy’s previous resilience to the Iran war. It was trading above $90 on Thursday.

The Bank of England said it expects UK inflation to peak at around 3.2% later this year as households come under pressure from higher energy prices, according to its central forecast of oil prices falling to around $71 a barrel.

In a more moderate scenario for war, inflation would peak at around 3 percent before falling rapidly, leading the central bank to reduce borrowing costs. But economists said the situation largely depends on how the conflict develops.

Paul Dales, chief UK economist at consultancy Capital Economics, said: “It depends on what happens to energy prices and whether this leads to second-round inflation effects that could turn a temporary rise in inflation into a longer-lasting rise.”

While waiting for developments in the war, he said, “It doesn’t look like the BoE is actually close to raising interest rates.”