Bank of England Rate Rise to 4%: Another Hike Likely Unless Iran War Eases

The Bank of England rate rise announced on Thursday lifts borrowing costs to 4%, the first increase since August 2023, and the governor has made clear it may not be the last. The Monetary Policy Committee voted 8-1 to raise the base rate by a quarter of a point from 3.75%. Catherine Mann, the lone dissenter, wanted a half-point move to 4.25%.

The cause is the war involving Iran. Oil prices have stayed stubbornly above $100 a barrel in recent months as hopes faded of a deal to reopen the strait of Hormuz. The Bank now expects inflation to reach 4.9% by the middle of next year, well above the 3.2% it forecast in July. The consumer prices index stood at 3.5% in September.

Why the Bank of England rate rise was bigger news than expected

Several economists called the decision tougher than anticipated. ING’s James Smith said every element of it was more hawkish than forecast. He pointed out that two of the committee’s most dovish members, Alan Taylor and Swati Dhingra, backed an increase. He also noted that the Bank’s inflation peak is above most economists’ predictions, and that some officials were more open than expected about the need to tighten further.

The Bank’s reasoning centres on costs working their way through the economy. Businesses have so far absorbed higher energy bills, partly through hedging, but the committee thinks they will soon have to pass them on. It expects the Ofgem energy price cap to rise from the equivalent of £1,723 a year for a typical household to £2,150 in January, then climb again in April. Food price inflation could reach 4.75% by mid-2027. The MPC is also wary of workers demanding large pay rises to make up for the squeeze, which could entrench inflation.

A squeeze on households

The timing is awkward. The decision comes a week after John Healey promised “breathing space” for struggling consumers in his first budget. It will hit mortgage borrowers, and the committee itself expects real post-tax incomes to fall this year and next.

Will there be another increase?

Andrew Bailey was careful to avoid promising a long run of increases. He said the move should not be seen as the first in an inevitable sequence of hikes, but added that unless the Middle East conflict is resolved, it does not look like the last. In the committee’s minutes he said he could see the case for a further rise without news that eases inflation risks, followed by a more conditional approach.

The next decision is due on 17 December. Markets were pricing roughly a 51% chance of a December hike, which Peel Hunt’s Kallum Pickering described as a coin toss that probably tracks investors’ views on whether peace talks will succeed. Oxford Economics expects another rise in December or February, and ING also expects one in February. Deutsche Bank’s Sanjay Raja is more restrained. He sees only one more increase, taking the rate to a peak of 4.25%, arguing that signs of second-round inflation effects remain minimal and that financial conditions have already tightened.

Markets: oil falls, shares wobble

Oil prices have eased in the past couple of days, with Brent trading around $97 on Thursday, after Democratic gains in US midterm elections. Some investors read those results as a possible constraint on President Trump’s ability to prolong the conflict. Bailey welcomed the drop but said it would have to be sustained to change his assessment.

Equity markets told a more complicated story. The FTSE 100 had been heading for a record close on cheaper oil but ended down 0.4% at 10,782.66 as US shares tumbled. Late in London trading the Nasdaq was down 3.7% and the S&P 500 2.9%, with worries that a Democratic-influenced Congress could curb data-centre spending that has fuelled AI-related share prices. Sterling barely moved, at about $1.347.

For households and businesses, the path of rates now depends largely on events far from Threadneedle Street. A durable fall in oil would ease the pressure for more tightening. If the conflict drags on, the Bank of England rate rise on Thursday may prove the first of several.

Explore more on this topic with Vexel Search.

File photo: Bank of England – London.jpg by MrsEllacott, CC BY-SA 4.0, via Wikimedia Commons.