Overview
Citi has revised its view of the Bank of England's near-term policy path, now expecting the Monetary Policy Committee to hold the Bank Rate at 3.75% at its meeting this week. The bank withdrew an April cut from its forecast, instead projecting the easing cycle will reach a terminal level of 3.25% with reductions in June and September. The change in guidance reflects increased uncertainty around energy prices after a new energy shock related to the Middle Eastern conflict, Citi said in a note.
Energy market effects and inflation
Recent volatility in energy markets has complicated the MPC's policy options. Pump prices have already risen 6.7% since the conflict began, which Citi estimates is equivalent to roughly 18 basis points on the Consumer Price Index. The bank also expects a more pronounced effect on airfares because jet fuel crack spreads have moved more sharply.
Household electricity and gas costs face material pressure: futures for gas and power on Friday implied about a 20% increase in the price cap from the second quarter. Citi notes that because the price cap is set quarterly, household bills will remain fixed through the second quarter despite futures signalling a higher cap later on.
How this shock differs from 2022
Citi points to important distinctions between the current shock and the energy crisis of 2022. The bank highlights that the UK economy is at a different point in the business cycle - characterised by a negative output gap, a rise in unemployment, and an inflation trend that is now moving down rather than up. Citi describes the present disruption as primarily a flow problem affecting marginal supply rather than a permanent loss of supply sources.
MPC reaction and voting dynamics
Given the uncertainty, Citi expects the MPC to adopt a cautious tone and preserve policy optionality. The bank considers two plausible voting outcomes at the meeting: either a unanimous vote to hold rates or a split decision. Citi judges a split vote to be the more likely outcome - a signal that some committee members may perceive the energy shock as temporary and would be prepared to resume cutting if conditions allow.
Market pricing and gilt market response
Market pricing has shifted markedly since the onset of the conflict. Expectations moved from over 50 basis points of rate cuts to pricing in about 20 basis points of hikes by Wednesday. Citi records that the average daily reassessment of end-2026 pricing has been 13 basis points, underscoring rapid changes in investor expectations.
The long end of the gilt market has seen accelerated selling, which Citi suggests may reflect renewed fiscal concerns. These include the potential cost of energy support measures and calls for accelerated defence spending, the latter of which the bank notes already faces funding shortfalls under current plans.
Fiscal policy and pass-through to businesses
Political considerations may add pressure on the MPC. Citi notes that the Labour government could introduce fiscal measures to shield households from higher energy costs, possibly including subsidies for energy bills or extensions to fuel duty relief. Such measures, if implemented, could complicate monetary policy by supporting demand during a period of elevated cost pressures.
On business pricing behaviour, Citi expects a more limited pass-through of higher energy costs to consumers than was observed in 2022. The combination of a negative output gap, rising unemployment, and fragile business sentiment suggests firms have reduced scope to pass on costs without risking non-linear effects in the labour market.
Guidance and minutes
Citi does not expect the MPC to declare the easing cycle finished despite current market pricing. The bank anticipates guidance that preserves the possibility of further rate reductions, conditioned on uncertainty abating. It adds that the individual paragraphs from members in the meeting minutes will be important for understanding how each policymaker views the prospect of looking through the energy shock.