The Bank of England looks set to leave Bank Rate at 3.75% on Thursday, even after oil prices spiked above $100 a barrel during the U.S.-Iran conflict. British inflation fell to a 15-month low of 2.6% in June, yet interest rate futures and economists disagree sharply about what the BoE does after this week.
The Bank of England looks set to keep interest rates unchanged at 3.75% on Thursday, despite a recent spike in oil prices above $100 a barrel which may test whether it can avoid raising borrowing costs in response to the U.S.-Iran conflict. So far, British inflation has come in below the BoE's forecasts, dropping to a 15-month low of 2.6% in June.
A lag in how regulated domestic energy prices respond to higher wholesale costs means Britain now has lower inflation than the United States and the euro zone, where the European Central Bank looks likely to raise rates for a second time this year in September or October.
Markets and economists split over the BoE outlook
Neither economists polled by Reuters nor financial markets see any real chance of a rate rise this week, but there is a sharp split on the longer-term outlook. After last week's rise in oil prices, interest rate futures moved to price in a two-in-three chance of a quarter-point BoE rate rise in September and almost three moves by next June.
Even after a fall in oil prices to $90 a barrel on Monday, markets still fully priced in a rate hike by November. But only a handful of economists expect a hike this year.
Henry Cook, a senior economist at Japan's MUFG, scrapped a previous call for a precautionary BoE rate rise similar to the ECB's. According to Reuters, Cook pointed to three downside surprises in a row on inflation and "plenty of signs of slack within the labour market".
BoE forecasts revised lower as energy futures cool
In April, the BoE forecast inflation would peak at around 3.6%-3.7% at the end of 2026 under two of its three scenarios for oil prices and other economic developments, but in June it revised that down to just over 3.25%. Oil futures are still in line with the mildest of those three scenarios, and the futures curve for natural gas prices, which hit a four-month high last week, is close to the middle scenario.
Bailey resists following the ECB
British inflation has been above its 2% target for most of the past five years. Chief Economist Huw Pill, who voted for a rate rise in April and June, fears a second oil price shock in four years could make households and businesses expect higher inflation for years to come.
Governor Andrew Bailey, however, has said the BoE does not need to raise rates like the ECB because it had cut them by less before the Iran war started at the end of February. British mortgage rates and business borrowing costs rose almost immediately when the BoE made clear in March that rate cuts previously expected in 2026 were unlikely.
On Thursday, Bailey is likely to stress that the BoE will keep a keen eye on increases in wages and prices not directly linked to higher energy prices. Household and business inflation expectations rose sharply at the start of the conflict, but recent data, including on wages, has offered some grounds for relief.
Source: Investing.com
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