The Bank of England chose to maintain its current policy stance amid ongoing disruptions from the Middle East conflict, yet signals for a potential policy shift are becoming clearer. Governor Andrew Bailey stated that the Middle East conflict has had a "significant impact" on the trajectory of the UK Consumer Price Index and that the central bank's role is to prevent the effects of such shocks from becoming entrenched. He forecasts that the inflation rate will be slightly above 3.5% by the end of the year.
On April 30, the Monetary Policy Committee voted 8-1 to keep the benchmark interest rate unchanged at 3.75%, aligning with market expectations. However, several committee members explicitly indicated that if energy prices remain persistently high, they would not rule out supporting a rate increase in upcoming meetings. Prior to the decision's announcement, oil prices had surged to wartime highs, approaching the £130 per barrel threshold set in the bank's most pessimistic scenario, further intensifying market anxiety.
Notably, due to the high uncertainty stemming from the situation involving Iran, the Bank of England unusually abandoned a single central inflation forecast. Instead, it presented a framework of three scenarios based on different paths for energy price movements and secondary inflationary effects. All three scenarios indicated that interest rates would likely need to increase further.
All three scenarios point towards the need for higher interest rates, with the worst-case outcome requiring substantial policy tightening. The three inflation scenarios released by the Bank of England provide important reference points for interpreting the future policy path. Several officials and Governor Bailey identified the middle scenario as the most probable baseline: inflation would peak at 3.7% before the end of the year, accompanied by moderate secondary effects.
However, the most pessimistic scenario has raised greater market alertness. If oil prices remain around £130 per barrel, inflation could climb to a peak of 6.2% in early 2027 and stay persistently above the 2% target throughout the forecast period. Under this scenario, models suggest the policy rate might need to be increased by 66 to 151 basis points. Bailey stated he assigns "some weight" to this outcome.
All three scenarios clearly indicate that, against the backdrop of extreme volatility in energy markets, the path for interest rates faces significant upside risks.
The inflationary pressure from the Middle East conflict is already becoming apparent. Driven by motor fuel costs, the UK's headline inflation rate rose to 3.3% in March.
Looking ahead to the second half of the year, the UK household energy price cap is due for another adjustment in July, with electricity and gas bills expected to rise further. This creates pressure for inflation to remain elevated into the second half of 2026.
Simultaneously, the committee noted that the overall tightening of financial conditions since the outbreak of the Middle East conflict, combined with a weak economic outlook and a softening labour market, would somewhat constrain the upward momentum of inflation. The MPC maintained its existing language, stating it remains prepared to "take action" should more concerning inflation signals emerge.
Several committee members conveyed hawkish signals. Chief Economist Huw Pill was the sole member voting for an immediate rate hike at this meeting, but the hawkish contingent appears to be growing. Deputy Governors Dave Ramsden and Clare Lombardelli, alongside external members Megan Greene and Catherine Mann, all signalled that if energy prices do not decline swiftly, a further tightening of financial conditions might be necessary.
Governor Bailey characterized holding rates steady as a "reasonable position" given the UK's weak economic backdrop, while also stating that interest rates might need to be raised if energy supplies continue to experience substantial disruptions.
Ahead of the rate decision, markets had fully priced in three cumulative 25-basis-point rate hikes by the Bank of England this year, with the first increase potentially arriving as early as June.
Comments