LONDON, July 27 - The Bank of England looks set to maintain its Bank Rate at 3.75% on Thursday, despite a recent rebound in oil prices that pushed Brent above $100 a barrel and raised fresh questions about whether the central bank will need to respond to the fallout from the U.S.-Iran conflict.
So far, inflation in Britain has run cooler than the Bank of England expected. Consumer price inflation dropped to a 15-month low of 2.6% in June, a result that underpins the case for leaving borrowing costs unchanged this week. A lag in how regulated domestic energy prices adjust to rises in wholesale costs is one reason Britain’s inflation rate currently sits below comparable measures in the United States and the euro zone. That divergence matters because the European Central Bank is seen as likely to raise rates for a second time this year in September or October.
Markets and economists split on the medium-term outlook
A decision to raise Bank Rate now would be politically sensitive. A move higher would represent a setback for the new Prime Minister Andy Burnham, who has campaigned on reducing the cost of living, and would complicate fiscal planning ahead of his government’s first annual autumn budget when higher borrowing costs could weigh on public finances.
Economists surveyed by Reuters and financial market indicators show little expectation of a rate rise at this week’s meeting. That consensus, however, masks a sharp division over the path of policy beyond the immediate decision. Following last week’s spike in oil prices, interest rate futures shifted to imply a two-in-three chance of a quarter-point BoE rate rise in September and priced in almost three moves by next June. Although oil then eased to $90 a barrel on Monday, markets still fully priced in a rate hike by November.
Only a minority of economists now expect the BoE to hike this year. Henry Cook, senior economist at MUFG in Japan, reversed an earlier call that the Bank would make a precautionary rise similar to the ECB. "We’ve had three downside surprises now in a row on inflation and plenty of signs of slack within the labour market," he said.
BoE inflation scenarios and energy price paths
In April, the Bank forecast inflation would peak at around 3.6%-3.7% at the end of 2026 under two of its three scenarios for oil prices and other economic developments. By June, that peak projection was revised down to just over 3.25%.
Current oil futures remain consistent with the BoE’s mildest of the three scenarios. The futures curve for natural gas - which hit a four-month high last week - sits close to the Bank’s middle scenario. Those relative positions are an important input for policymakers weighing the risk that higher wholesale energy costs could translate into persistent inflationary pressures.
Persistent inflation dynamics and central bank concerns
Despite the recent moderation, British inflation has been above the BoE’s 2% target for most of the past five years. Huw Pill, the Bank’s Chief Economist, who voted for a rate rise in both April and June, has flagged the danger that a second oil price shock in four years could alter inflation expectations among households and firms and entrench higher inflation for longer.
Governor Andrew Bailey has argued that the BoE does not need to react in the same way as the ECB because the United Kingdom had cut interest rates by less prior to the Iran conflict at the end of February. Financial conditions adjusted quickly in March when the Bank made clear that anticipated rate cuts in 2026 were unlikely; mortgage rates and business borrowing costs rose almost immediately in response to that shift in guidance.
On Thursday, Governor Bailey is expected to emphasize the Bank’s focus on wage growth and price increases not directly tied to energy, while continuing to monitor household and business inflation expectations. Those expectations surged early in the conflict but recent data, including on wages, have provided some limited reassurance.
Review of quantitative tightening
Alongside the interest rate decision, the BoE is likely to publish analysis of how its bond sales programme - quantitative tightening, or QT - is affecting markets. That report would arrive before the Monetary Policy Committee’s annual vote on the pace of QT in September.
Last year the Bank slowed the pace of QT to ?70 billion a year from ?100 billion and concentrated sales toward shorter-dated gilts. A June BoE survey showed market participants expect QT to slow further to ?50 billion.
Before the decision to slow sales, the BoE had estimated QT had added 0.15-0.25 percentage points to long-term gilt yields. Research published by the Bank in May suggested a larger effect - closer to 0.4 percentage points. Costas Milas, a co-author of that study and a professor at the University of Liverpool, said the Bank may need to reassess the pace of bond sales but should not abandon QT entirely. "If we just ignore QT or pause QT ... perhaps the BoE might have to raise Bank Rate earlier than it possibly has in mind," he said.
Exchange rate note: ($1 = 0.7505 pounds)