The Bank of England (BoE) is caught between an economic slowdown and a resurgence in inflation. Maintaining interest rates at their current level may be a temporary choice, but the real test will unfold in the coming months.
The BoE is set to announce its interest rate decision at 7:00 PM Beijing time on Thursday, alongside updated economic forecasts. Governor Andrew Bailey will hold a press conference half an hour later. Markets widely anticipate that the Bank's Monetary Policy Committee (MPC) will keep the benchmark rate at 3.75%, continuing its "wait-and-see" approach in response to the sharp volatility in oil and gas prices triggered by the Middle East conflict.
Voting Divergence: Rate Hike Support Remains a Minority
Currently, the trajectory of UK inflation is heavily dependent on developments in the Middle East. While recent data shows some easing of domestic inflationary pressures, oil and gas prices have risen markedly since the last meeting in June. Renewed military clashes between the US and Iran after a brief ceasefire have refocused market attention on energy costs. However, economists predict that the number of MPC members favouring an immediate rate hike remains small. A Bloomberg survey indicates that out of the nine MPC members, only two are expected to support a rate increase this time. Analysts suggest that the tightening of financial conditions since the outbreak of the conflict has bought the BoE more time for observation. Nevertheless, policymakers may still keep the option of future rate hikes open. The majority of MPC members are expected to support keeping rates unchanged, as they balance inflation risks against weak economic growth. With subdued economic activity, weakening labour demand, and rising real financing costs, the Bank believes the risk of businesses raising prices and employees demanding higher wages has decreased. Despite this, BoE Chief Economist Huw Pill and MPC member Megan Greene are expected to maintain their hawkish stance, fearing that rising energy prices could trigger second-round inflation effects, prolonging price pressures. External member Catherine Mann is also considered a potential supporter of an immediate rate increase. Although this meeting could mark the fifth consecutive pause in rate hikes, the market has not fully abandoned expectations of future tightening. Traders currently estimate a roughly 65% probability of a rate hike in September and are pricing in cumulative increases of nearly 50 basis points by the end of the year.
Forward Guidance: BoE Likely to Avoid Dovish Signals
In terms of policy communication, the BoE is expected to maintain flexibility. The Bank's current guidance states that the committee "stands ready to act" to ensure inflation returns sustainably to the 2% target. Market observers believe policymakers will not easily release dovish signals to avoid weakening market expectations for future rate hikes. Sanjay Raja, UK economist at Deutsche Bank, commented that in the current environment, the MPC has no reason to prematurely narrow its policy options. Maintaining the existing guidance allows the Bank to respond flexibly to future economic changes, whether it be further weakening of the economy or persistently high inflation. The market will also closely monitor any shifts in the stance of key figures like Governor Bailey for signs that the BoE is gradually moving towards a more hawkish policy.
Economic Forecasts: Energy Prices Could Push UK Inflation Higher Again
UK inflation is currently below the Bank's previous forecasts, but energy risks from the Middle East conflict are altering the outlook. In April, due to the uncertainty caused by the conflict, the BoE suspended its main inflation forecast, opting instead for three different scenarios. Bloomberg analysis suggests that the Bank may resume its core inflation forecast, but scenario analysis could still play a key role in future communications. "We believe that most policymakers are likely to view a scenario similar to the April 'Scenario B' as the most plausible path forward," said Dan Hanson, Chief UK Economist at Bloomberg Economics. "Regardless of which path the BoE chooses, the sharp volatility in energy prices over the past week could render its forecasts outdated." The UK's Consumer Price Index (CPI) rose 2.6% year-on-year in June, down from 3% in February. However, the National Institute of Economic and Social Research (NIESR) predicts that inflation will rise again due to a 13% increase in the household energy price cap from July. NIESR forecasts that UK inflation will peak at 3.8% in February next year and will not return to the BoE's 2% target until 2029. NIESR stated that its forecast assumes a return to normal shipping through the Strait of Hormuz by the end of the year. However, if energy prices rise further and persist longer than expected, the UK inflation peak could reach 4.8%. Despite this, NIESR expects the BoE to hold rates steady both this year and next. David Aikman, NIESR's Economic Director, said that the BoE's decision to keep rates unchanged is "broadly reasonable," but this judgment depends on the trajectory of energy prices. "If energy prices continue to rise and stay high, the policy assessment will change, and the BoE may need to act," he said.
Quantitative Tightening: Another Key Market Focus
Beyond the rate decision, the market is also watching for new signals regarding the BoE's quantitative tightening (QT) programme, i.e., the shrinking of its balance sheet. The Bank will formally decide on the size of its bond sales for the coming year in September, but this meeting may provide early clues. In recent years, the BoE has been steadily reducing the large bond holdings accumulated during the pandemic and financial crisis by ceasing reinvestment of maturing bonds and actively selling assets. The BoE plans to sell approximately £21 billion in bonds by September of this year, with markets expecting a similar pace to be maintained after October. However, as the Middle East conflict pushes up UK gilt yields, and with borrowing pressures from government fiscal spending plans, some investors are calling for the Bank to slow down or even pause its long-term bond sales. The UK 30-year gilt yield is currently just below the 28-year high set in May, indicating increasing pressure in the bond market.
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