Bank of England set to raise interest rates for first time in three years as Iran war fuels inflation

The Bank of England is widely expected to raise interest rates for the first time in three years on Thursday as mounting inflationary pressures linked to the US-Iran war complicate the central bank's efforts to keep prices under control.

Economists polled by Reuters expect the Monetary Policy Committee (MPC) to vote 7-2 in favour of increasing the Bank Rate to 4% from 3.75%. The move would mark the first rate hike since August 2023 and the first change in borrowing costs since the central bank cut rates last December.

At its previous meeting in September, the MPC voted 6-3 to keep interest rates unchanged. However, rising energy costs and signs of stronger-than-expected economic growth have increased the likelihood of a shift towards tighter monetary policy.


Read more: US stocks today: Dow rallies 1,500 pts, S&P, Nasdaq over 1% as Democrats win midterm elections

The prolonged US-Iran conflict has pushed oil prices towards $100 a barrel, while natural gas prices have climbed to around three times their pre-war levels. The longer the conflict continues, the greater the risk that higher energy costs will spread across the broader British economy, adding to inflationary pressures, Reuters reported.

Britain's inflation rate rose more than expected to 3.5% in September, significantly above the Bank of England's 2% target and higher than the 3% forecast in its previous set of projections in July.

The British economy has also demonstrated greater resilience than anticipated. Gross domestic product in August recorded its strongest annual increase since 2022, while the UK registered joint-fastest economic growth among Group of Seven economies in the first half of the year.

However, there have so far been limited indications that higher prices are translating into significant second-round inflationary effects through wages. Businesses expect annual wage settlements of around 3.5% next year, broadly in line with expectations for 2026.

Read more: Asian shares mostly advance following US midterms, though Kospi falls on selling of chipmakers

The government's first annual budget under Finance Minister John Healey last week also did little to materially alter the outlook for economic growth or inflation.

Bank of England Governor Andrew Bailey has previously pointed to differences between the current inflationary environment and the surge in prices following Russia's invasion of Ukraine in 2022. Businesses appear to be absorbing higher costs to a greater extent than they did during that period, when inflation peaked at 11%.

BoE Policymakers Divided Over Inflation Risks
Bank of England policymakers remain divided over whether the central bank should wait for clearer evidence of second-round inflationary effects before raising rates or act earlier to prevent inflation from becoming more persistent.

Bailey has defended the decision to keep rates unchanged so far, noting that financial markets have already tightened monetary conditions following the outbreak of the conflict. Investors have abandoned expectations of interest rate cuts this year, pushing up borrowing costs and mortgage rates.

However, some policymakers, including Catherine Mann, have expressed concern that rising market expectations for interest rates partly reflect fears that the central bank could lose control of inflation.

Financial markets are currently pricing in at least three additional quarter-point rate increases next year, following the expected hike this month. Such a trajectory could push British interest rates above levels projected for the United States.

However, economists broadly expect a more gradual tightening cycle, with previous market expectations of aggressive Bank of England rate increases having proved premature.

Peder Beck-Friis, an economist at PIMCO, which manages more than $2 trillion in assets, expects just one additional rate increase in February next year, followed by an extended pause. He cited the relatively weaker outlook for the British economy compared with the United States.

Reuters reported that the outlook for monetary policy will largely depend on whether higher energy prices translate into broader inflationary pressures, particularly through wages and underlying prices. Without stronger second-round effects on core inflation, further monetary tightening could remain limited.

(Disclaimer: This article is based on inputs from agencies. These do not represent the views of The Economic Times.)