United Kingdom: Bank of England maintains its main rate and presents assumptions on the impact of war

The Bank of England decided to keep its main interest rate at 0.1% on Thursday, continuing the pause initiated in March as the institution aimed to assess the impact of the Middle East conflict on inflation. The Monetary Policy Committee (MPC) of the BoE made the decision by an 8-1 vote, consistent with Reuters consensus, with the institution’s chief economist in favor of a 25 basis point rate hike.

Despite concerns about potential second-round effects from rising energy prices, the labor market weakening, and businesses passing on cost increases, the MPC highlighted the need to balance inflationary pressures with economic stability. The Governor of the BoE, Andrew Bailey, emphasized the challenging choice regarding inflationary pressures as a result of the energy price increase triggered by the conflict in Iran.

Bailey warned of the lingering impact on the UK economy, especially on food prices, due to the prolonged conflict, indicating that the BoE might have to act even before tangible evidence of the conflict’s impact is available. While acknowledging the possibility of rate increases, Bailey suggested that there is room to absorb inflationary pressures without immediate rate hikes.

Investors are concerned about the UK’s vulnerability to high energy prices given its significant natural gas consumption. Recent data showing rising input costs for businesses have led to inflation forecasts being revised upwards, raising fears of a potential slowdown in GDP growth due to the conflict.

The BoE presented three scenarios based on energy prices and different levels of second-round effects of inflation, with the worst-case scenario projecting inflation peaking at 6.2% over the next three years. The central bank indicated that if this risk materializes, a strong monetary policy tightening would be necessary.

The decision by the BoE follows months of rate stability, with investors expecting three rate hikes this year amid uncertainties about the economic impact of the conflict. The Bank’s choice to maintain rates reflects concerns about inflation and economic growth, aligning with the cautious approach of other central banks, like the Federal Reserve, amid rising geopolitical tensions.