Bank of England keeps rates on hold at 3.75% as Iran war shakes outlook

The Bank of England voted to keep its key interest rate on hold at 3.75% on Thursday, as widely expected by economists, as the Iran war continues to pose a dilemma for policymakers.

The central bank was widely expected to stand pat on rates as it waits to see how the energy price crunch caused by the Iran war, and a concurrent reignition of inflationary pressures in the U.K., manifest themselves in the economy.

The bank's Monetary Policy Committee voted in an 8-1 split to maintain the benchmark rate, known as "Bank Rate", at 3.75%, with known hawk BOE Chief Economist Huw Pill the only dissenter voting for a 25 basis-point increase.

The British pound was up 0.4% against the dollar, at $1.3473, after the decision, while borrowing costs fell as the yield on the benchmark 10-year gilt dropped 6 basis points to 5.014%.

In a summary of its decision-making on Thursday, the BOE said it expected war in the Middle East to continue to push energy and fuel costs higher, noting that its ability to mitigate these pressures with monetary policy was limited.

"The conflict in the Middle East means that prospects for global energy prices are highly uncertain. Monetary policy cannot influence energy prices but will be set to ensure that the economic adjustment to them occurs in a way that achieves the 2% inflation target sustainably," it noted.

"The policy stance required to achieve this will depend on the scale and duration of the shock, and how it propagates through the economy."

## More price rises coming

The most recent inflation data showed the consumer price index rose to 3.3% in March, up from 3% the previous month, as higher fuel prices drove the rate higher.

The BOE said Thursday that inflation is "likely to be higher later this year as the effects of higher energy prices pass through" and that it was wary of second-round effects — such as workers demanding higher wages in the face of higher living costs, potentially fueling more inflation — in the economy.

"There is a risk of material second-round effects in price and wage-setting, which policy would need to lean against. But the labour market continues to loosen, and a weakening economy could contain inflationary pressures. Financial conditions have tightened since the conflict began, which will help to reduce inflation over time," the BOE said.

"Taking all the risks to the economic outlook into account, the Committee judges that it is appropriate to maintain Bank Rate at this meeting."

The BOE nonetheless included three scenarios reflecting the possible outlook for the U.K. economy depending on the scale and duration of the energy price rises, and the severity of any second-round effects that might materialize.

In the most benign scenario, inflation would rise to 3.5% at the end of this year before falling back. In the most severe, inflation could rise "much more sharply" and peak at 6.2% at the start of 2027 and remain elevated above the bank's 2% inflation target until 2029.

In that most adverse scenario, the BOE said Bank Rate would rise to around 5.25% in 2027. While this would reduce the expected inflation peak in this scenario, it would "come at the cost of a larger output gap and would raise the risk of a recession."

Deputy governor Clare Lombardelli said that, while this is not viewed as "a central case", it is "plausible and would require policy to respond more forcefully to inflationary pressures."

The bank stands ready to respond with monetary policy if necessary, according to the statement, but David Rees, head of global economics at Schroders, said the bar for rate hikes "remains high."

"The risk of persistently higher inflation, along with speculation about political change after the local elections, has lifted gilt yields to near 20-year high," he added in emailed comments.

"With some slack emerging in the labour market and growth likely to weaken if disruption drags on, we doubt the Bank will tighten unless economic activity stays strong enough to absorb it," he noted.