The Bank of England has held rates unchanged at 3.75% for the fifth time in a row, marking the lowest level since February 2023. However, the decision revealed a more divided Monetary Policy Committee than expected, with three policymakers voting for a rate hike to 4% compared to the widely anticipated 7-2 split. As reported by The Economic Times, Catherine Mann, Megan Greene, and Chief Economist Huw Pill joined forces to push for an immediate increase, citing renewed conflict between the United States and Iran as the primary trigger. The rest of the MPC appeared content with the wait-and-see approach, with Governor Andrew Bailey maintaining his stance that domestic conditions are on balance more benign as regards the prospects for inflation. Following the announcement, sterling softened slightly against the dollar while 2-year gilt yields fell by about 2 basis points, with the central bank noting that global conditions look to be more uncertain and inflationary. According to Reuters, the central bank's Monetary Policy Committee voted 6-3 to leave rates on hold on Thursday, with forecasts incorporating financial market expectations that imply a high probability of two interest rate hikes by the third quarter of 2027.
The BoE has outlined three possible economic scenarios for the UK, with its central forecast projecting inflation to fall below the 2% target over the medium term as economic growth gradually strengthens. Under the central projection, the Bank of England expects inflation to peak at 3.2% in the fourth quarter of 2026 before slowing below the 2% target to 1.7% in the first quarter of 2028, with projections indicating rates will stay above target until early 2028 when it would dip below 2%. The central scenario assumes oil prices gradually ease from around $76 per barrel during the third quarter of 2026 to about $71 by the end of the forecast period, while natural gas futures are expected to peak at just over 123 pence per therm in the fourth quarter before falling to just under 60 pence by the end of the forecast horizon. In a milder scenario, inflation is projected to reach 2.7% in the fourth quarter of 2026, ease to 2.4% by the third quarter of 2027, and settle at 1.7% in both the third quarter of 2028 and the third quarter of 2029. The adverse scenario presents a more challenging outlook, with inflation climbing to 3.1% in the third quarter of 2026 and rising further to 4.1% in the third quarter of 2027 before easing to 2.8% in 2028 and 2.4% in 2029.
The BoE's central scenario shows economic growth forecast to remain steady at an annual rate of 1.1% in both the third quarter of 2026 and the third quarter of 2027, before accelerating to 1.7% in the third quarter of 2028 and moderating slightly to 1.6% a year later. In the milder case, growth remains at 1.1% through 2026 before improving to 1.6% in both 2028 and 2029. The adverse scenario presents a more challenging outlook, with economic growth projected at 1.1% in the third quarter of 2026, slowing to 0.9% in 2027 before recovering to 1.6% in 2028 and 1.7% in 2029. The central bank also expects the energy price shock to generate only moderate second-round effects on inflation, with weak demand and a softer labour market expected to prevent broader inflationary pressures from taking hold. The milder scenario assumes oil and gas prices remain around 3% and 6% lower, respectively, than in the central projection, broadly reflecting market conditions following the U.S.-Iran memorandum of understanding.
The BoE's cautious stance has been reflected in market expectations, with interest rate futures indicating investors are pricing in a 25-basis-point rate increase by November, followed by another move up by March 2027. However, economists expect that the majority of the MPC will view rates as too high to ensure a gradual decline in inflation along with a weakening labour market. Schroders senior economist George Brown noted that "For now, the Bank is not seeing enough to abandon its wait-and-see approach. Despite the sharp rise in energy prices, the majority appear unconvinced this will translate into more persistent domestic inflation." The FTSE 100 stock index, which hit a record high earlier on Thursday, was last up 0.2% following the rate decision. Despite the rate hold, the market response suggests investors are positioning for potential future tightening, with most economists surveyed by analysts expecting the Monetary Policy Committee to keep rates at 3.75% - that is, they do not plan to change them this year.
If Britain's central bank continues to keep rates on hold, it will provide relief for new Prime Minister Andy Burnham who has prioritised cost-of-living measures, including scrapping a tax on household electricity bills which the BoE said would help lower inflation by a tenth of a percentage point. As reported by The Economic Times, the BoE's cautious approach contrasts with the European Central Bank's decision to raise interest rates in June, while Chair Kevin Warsh of the Federal Reserve expressed "no tolerance" for inflation. The central bank raised its estimate of the market impact from the reduction on its balance sheet of hundreds of billions of pounds worth of government bonds, judging it had added a "modest" 0.2-0.3 percentage points to gilt yields since 2022, up from 0.15-0.25 percentage points in a similar assessment last year. This assessment comes ahead of an annual MPC vote in September on the pace of quantitative tightening, with financial market participants expecting a further slowdown to £50 billion.
