The Bank of England has warned that interest rates are likely to rise if the war in Iran continues, with inflation now on course to reach 4 per cent. Its nine-member monetary policy committee voted 6 to 3 yesterday to leave borrowing costs at 3.75 per cent, the sixth hold in a row.
The decision was expected by markets and the pound traded flat against the dollar after the announcement.
The Bank expects inflation to rise to more than double its 2 per cent target in the early months of next year, because of the surge in global oil and gas prices since the Middle East conflict began more than six months ago. More than half of the overshoot is down to the war in Iran, the committee said.
Andrew Bailey, the Bank’s governor, said that the longer hostilities continued, “the bigger the impact it will have on inflation, and the more likely it is we will need to raise Bank Rate to ensure that inflation falls back to our 2 per cent target”.
In a statement explaining his vote to hold, Bailey wrote that there was now a “more prominent” upside inflation risk because of the re-intensification of fighting between the United States and Iran in recent weeks, adding that there seemed now to be a “loss of urgency to find solutions”.
The Office for National Statistics reported this week that inflation jumped to 3.1 per cent on an annual basis in August, up from 2.9 per cent the previous month.
The committee said it was not overly concerned about wage growth or company profit margins, the so-called second-round effects that typically occur after an inflation shock.
Bailey was one of six members who voted to keep policy unchanged. Huw Pill, the Bank’s chief economist, and the external members Catherine Mann and Megan Greene voted to lift the base rate by 0.25 percentage points to 4 per cent.
UK government borrowing costs fell after the announcement. The yield on the benchmark ten-year bond slid by 0.10 percentage points to 5.2 per cent and the yield on the 30-year bond dipped by 0.14 percentage points to 5.72 per cent. Yields move inversely to prices. The FTSE 100 gained 0.6 per cent.
The price of a barrel of Brent crude oil dropped by 2.3 per cent to $103.40, down from recent highs near $110, leading to corresponding falls in European and US sovereign bond yields.
Dani Stoilova, European economist at BNP Paribas, said: “The MPC remains hesitant to hike, unlike other major central banks.”
Rob Wood, chief UK economist at Pantheon Macroeconomics, said that the committee’s focus on the upside risks of inflation indicated that “a November hike [is] highly likely unless energy prices fall sharply”, adding that another rate rise would come in February. The committee next meets on 5 November.
Alongside the conflict, the Bank warned of stronger-than-feared food price inflation because of climate change and the El Niño weather pattern, of the Russia and Ukraine war disrupting global grain supplies, and of excessive demand for components used in the roll-out of artificial intelligence.
Most of the committee thought Britain was at least nearing the adverse scenario mapped out at its previous meeting in July, in which the Middle East war causes a lasting increase in energy prices and requires several interest rate rises.
The Bank said GDP was now expected to grow by 0.4 per cent in the third quarter of this year, after a series of better-than-expected monthly output readings. In the first six months of the year, Britain expanded at the fastest pace among the G7 economies.
The Bank has also proposed to the Treasury a restructuring of its bond-selling programme, known as quantitative tightening, that would shrink its balance sheet by an average of £46bn a year until 2034. The Treasury must decide whether to implement the package by April 2027.
The US Federal Reserve lifted its main interest rate on Wednesday for the first time in three years, to a range of 3.75 per cent to 4 per cent. The Bank of Japan is expected to raise its main interest rate today, after the European Central Bank did so last week.
