The Bank of England is widely expected to hold interest rates steady at 3.75% on Thursday, diverging from global peers like the U.S. Federal Reserve. The decision comes as U.K. inflation climbs to 3.1% in August, driven largely by surging energy costs and fallout from the ongoing conflict with Iran.
While central banks in the United States and Europe move toward tighter monetary policy, British policymakers face a more delicate balancing act. Markets are pricing in more than an 80% chance that the central bank will leave rates unchanged, according to LSEG data cited by CNBC. Economists expect a majority of the nine-member Monetary Policy Committee will want to see more evidence that higher inflation is feeding into underlying prices and wages and will therefore vote to keep the bank’s main rate unchanged.
Rising Inflation and the Energy Shock from the Iran War
Official figures released Wednesday by the Office for National Statistics (ONS) show that the U.K.’s consumer prices index rose to 3.1% in August from 2.9% the month before, moving further above the central bank’s 2% target. The jump represents the first time inflation has climbed above 3% since March. Analysts point directly to external pressures, including rising motor fuel costs that surged 23% year-on-year, alongside higher airfares and prices at the pump. As a net energy importer, the U.K. is particularly vulnerable to external energy shocks, and is still grappling with a cost-of-living crisis brought on by post-Covid inflation and the Russia-Ukraine war’s impact on natural gas supplies. Much of this renewed pressure traces back to geopolitical conflict in the Middle East. Interest rates in the U.K. had been trending downward from a 15-year high of 5.25% until the U.S. and Israel attacked Iran in late February. The Iran war led to sharp increases in oil and gas prices, partly because the crucial Strait of Hormuz has been largely closed to traffic ever since. Although the inflation increase was unlikely to convince the Bank of England to hike interest rates just yet,
it could raise fresh concerns about the outlook for inflation among policymakers, said Scott Gardner, an investment strategist at J.P.
“The U.S.-Iran conflict began over six months ago but higher energy costs are still filtering through to business input prices and household spending,” he said in a note Wednesday.
Scott Gardner, investment strategist at J.P. Morgan Personal Investing
Diverging Paths Among Global Central Banks
A decision by the Bank of England to hold rates would mark a clear departure from other major monetary authorities. The U.S. Federal Reserve announced a quarter-point hike on Wednesday, its first hike since 2023. Last week, the European Central Bank announced its second rate hike this year, after raising rates in June for the first time in three years. Meanwhile, the Bank of Japan is expected to raise its key interest rate at the end of its two-day meeting on Friday. The Bank of England has not altered its key interest rate this year, having last changed rates in December with a 25-basis-point cut.
Despite the rising consumer price index, economists suggest the underlying domestic economy remains relatively soft. David Rees, head of global economics at Schroders, noted that a relatively subdued labor market and moderate wage growth should limit the extent to which imported price pressures become embedded in domestic wages and prices.
That assessment is shared across financial markets. Shreyas Gopal, an FX strategist at Deutsche Bank, said in a Wednesday note that the absence of any materially hawkish surprises in both this week’s U.K. labor market and inflation data had been enough for pricing for [hikes at] this upcoming meeting to fall back again.
Fiscal Pressures and What Lies Ahead for British Borrowers
Even if policymakers opt for a pause on Thursday, financial markets widely anticipate a rate hike of at least 25 basis points at one of the next two meetings, either in November or December. Households face an additional impending hurdle as households face another increase in their domestic energy bills beginning in October, which many economists are forecasting will push inflation even higher in coming months.
Global inflation concerns, political instability and apprehension about U.K. fiscal policy have put pressure on British government bonds, known as gilts, this year. Britain has the highest borrowing costs in the G7, with yields on its long-dated 20- and 30-year gilts approaching the 6% mark. Earlier this week, British newspaper The Telegraph reported that the Bank of England would announce plans to stop selling 20- and 30-year gilts alongside its interest rate decision. As well as impacting the cost of personal loans and mortgages, this places mounting pressure on public finances as the servicing of its debt accounts for a higher proportion of its spending.
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