Bank of England holds interest rates as Middle East war threatens UK inflation

The Monetary Policy Committee has held interest rates at 3.75 per cent on Thursday

Interest rates have been maintained as policymakers at the Bank of England cautioned the Iran conflict could send prices soaring as early as April. Members of the Monetary Policy Committee (MPC) kept interest rates unchanged at 3.75 per cent, with guidance towards cutting rates in forthcoming meetings now being abandoned entirely.

Several policymakers, including governor Andrew Bailey, said they “stand ready to act” in a warning that could intensify concerns about interest rates being raised later this year.

Governor Andrew Bailey noted that policymakers’ attention had shifted towards worries around elevated oil and gas prices filtering through into increased household bills and business costs over the coming months.

“War in the Middle East has pushed up global energy prices,” Bailey said, as reported by City AM.

“You can already see that at the petrol pump and, if it lasts, it will feed into higher household energy bills later in the year.

“The best way to tackle this is at the source by re-opening energy supply lines. We have held interest rates at 3.75 per cent as we assess how events unfold.”

Bailey added that the MPC’s principal task was to bring inflation back to two per cent. The Bank of England chief’s warning represents a stark contrast to the February meeting when he described revised forecasts on price growth as “good news”.

Inflation forecasts undo Reeves’ measures Inflation projections from April have now been revised upwards, reversing Rachel Reeves’ Budget measures that sought to reduce costs on energy bills and accelerate the decline in price growth.

Forecasters indicated that, due to an estimated 60 per cent increase in fuel prices, inflation was now anticipated to hold at three per cent in the second quarter of the year. Price growth was then predicted to climb further to 3.5 per cent, though forecasts were subject to revision depending on any alteration in trade flows through the Strait of Hormuz.

The Brent Crude oil price climbed by eight per cent on Thursday to above $114 whilst gas prices jumped on reports that a key site in Qatar sustained “extensive damage” from Iranian strikes.

Oil prices have surged by over 50 per cent since the war’s onset whilst a European benchmark for gas prices has doubled.

Treasury and Office for Budget Responsibility (OBR) officials employ a rule of thumb to assess the effects market changes can have on the UK economy. It indicates that a 20 per cent rise in energy prices contributes to an additional one percentage point increase in inflation whilst reducing GDP growth by 0.5 percentage points.

Economists have cautioned that the impact of market prices depends on the duration of the conflict.

Rate-setters at the Bank suggested that households and businesses remained highly “sensitive” to inflationary shocks, which could translate into more pessimistic expectations. They established a six-week deadline for collecting evidence on the war’s impact, with a protracted conflict leading to a “self-perpetuating behaviour in wage and price dynamics”.

External member Swati Dhingra, who has generally supported swifter interest rate reductions over the past year, proposed that an extended war could “warrant” a rise in interest rates. Alan Taylor, also perceived as a dovish MPC member, said there was a “high bar to hiking” rates.

Chief economist Huw Pill said: “The potential for second-round effects following recent events in the Middle East remains substantial, justifying caution in monetary policy setting.

“Whilst financial conditions have tightened in recent weeks, whether this proves sufficient to contain potential upside risks to price stability stemming from energy prices is an open question.”