Interest rates held but Bank signals rise if energy prices stay high

The Bank of England kept its benchmark interest rate at 3.75% for the sixth consecutive meeting, but Governor Andrew Bailey warned that persistently high energy prices – driven by the US‑Israel war with Iran and its disruption of global fuel supplies – make a future rate rise more likely. Six of the nine Monetary Policy Committee members voted to hold the rate, while three, including chief economist Huw Pill, favoured a lift to 4%. The decision came as the Bank raised its inflation forecast, expecting it to sit “slightly above 4%” at the start of next year, and signalled that the price cap on household gas and electricity bills for January would have to be increased substantially. The central bank also announced a slowdown in its quantitative‑tightening programme, pausing the annual sale of UK government bonds and moving to a smaller, eight‑year drip‑feed, a move that immediately pushed yields on 30‑year gilts down to 5.75% and 10‑year gilts to 5.22%.

The backdrop to the rate hold is a surge in petrol and diesel prices that has fed inflation up to 3.1% in August, well above the Bank’s 2% target for nearly two years. While the UK economy has proved more resilient than expected – with growth for the July‑September quarter revised up to 0.4% from 0.1% – the Bank noted that higher energy costs have not yet spilled over into broader price pressures, allowing it to lower its food‑price inflation forecast to 4% by year‑end, down from a previous 6‑7% estimate. Bailey stressed that the trajectory of inflation hinges on the resolution of Middle‑East conflicts and a return of energy prices to pre‑war levels; without those conditions, the Bank sees little scope for cutting rates. The decision also came as other major central banks moved aggressively, with the US Federal Reserve delivering its first hike in three years and the European Central Bank raising rates twice since June, underscoring the global fight against rising prices.

The policy shift has immediate implications for borrowers and the government’s financing costs. Mortgage lenders have already lifted the average two‑year fixed‑rate to 5.77% and the five‑year rate to 5.83%, the highest levels since May and November 2023 respectively, prompting concerns about higher monthly repayments for households. Bailey acknowledged the knock‑on effect on savings and spending, noting the economy’s “fortunate position” to absorb the increase but warning of potential savings erosion. On the fiscal side, the Bank’s decision to slow its gilt sales eases long‑term borrowing costs, as evidenced by the drop in gilt yields, and signals a more measured approach to unwinding the £895 billion bond portfolio built up during the pandemic and financial‑crisis era. The move suggests the Bank is decoupling its QT adjustments from the recent rise in long‑term yields, focusing instead on a gradual reduction of its £488 billion stockpile over the coming years.

⚡ Effects Interpreter