BoE delivers message Britons don’t want to hear as inflation – and rates – look set to rise

The US-Israel attack on Iran has already driven prices higher and not just at the petrol pumps, the Bank of England said on Thursday in a gloomy assessment of the UK’s economic outlook.
An inflation rate that was on track to fall from 3% to the Bank’s 2% target in the coming months is now expected to rise to 3.5%. That is one probable impact of the US and Israel’s war on Iran.
Higher transport and energy costs can quickly flow through to higher food prices, ratcheting up the consumer prices index when the previous trajectory was down.
It is not the news households wanted to hear after a long period of high inflation that everyone thought was over.
Likewise, businesses large and small will be reconsidering their investment decisions and how many people they hire as a result.
For the government, another rise in the cost of living is the last thing it needs heading into already difficult local elections.
The monetary policy committee (MPC) stopped short of making any predictions but the unanimous decision to hold interest rates at 3.75% is a signal that the thinking inside Threadneedle Street is moderately panicked.
MPC members are looking in both directions at once. One of them, Alan Taylor, who has warned against raising interest rates to deal with an externally induced price shock, said the pause signalled nothing more than a moment of contemplation.
But his was almost a lone view. While Swati Dhingra, like Taylor, has warned that the weakening economic outlook means inflation will fall over the longer term and for that reason has been a consistent supporter of lower interest rates, she said she would be prepared to raise rates if the war continued and inflation became more embedded.
Officials are weighing up, on the one hand, how much workers can ask for in higher wages to compensate for higher inflation when unemployment is high and hiring is low. Coupled with this, businesses may seek to recover increased costs in the form of higher prices, especially in areas of the economy where competition has eroded or consumers are resigned to another inflation spike.
And on the other hand, an increase in the sensitivity of households to another bout of inflation – one that brings a decline in living standards – may trigger a big push for higher wages across the public and private sectors.
Like other central banks, the Bank of England sees both trends potentially dominating and wants to watch and wait.
It may be that the logic of the war – that Iran can plausibly shut the strait of Hormuz for many more months with just a few drones – is the only relevant piece of information the MPC needs. It means oil prices will stay high into the summer and interest rates, despite the damage they will cause, are likely to rise.
Financial markets certainly think so and are now betting that the Bank will raise rates as soon as June.