Interest rates held at 3.75% as Bank of England warns inflation could top 4%
The Bank of England has kept interest rates unchanged but warned that persistent Middle East tensions and higher energy prices have increased the risk of inflation remaining above
By The Guardian
UK interest rates have been held at 3.75%, but the Bank of England has signalled that it is prepared to act if higher energy costs lead to more persistent inflation.
The Monetary Policy Committee voted by six members to three to keep Bank Rate unchanged at its September meeting.
The three dissenting members wanted an immediate quarter-point increase to 4%, highlighting the growing debate within the Bank over how to respond to renewed inflationary pressure.
The decision is particularly important for households with mortgages and other borrowing, as well as businesses waiting for financing costs to fall.
Inflation reached 3.1% in August, remaining above the Bank's 2% target.
The Bank now expects inflation to rise further over the coming months, largely because of higher oil, gas and electricity prices associated with the continuing conflict in the Middle East.
Its latest projections indicate CPI inflation could reach around 3.75% during the final quarter of 2026 before moving slightly above 4% in the first quarter of 2027.
That represents a significant deterioration in the near-term outlook.
Energy prices are responsible for most of the change compared with the Bank's previous forecast, while policymakers are also watching for signs that businesses begin passing higher costs through to customers more widely.
Governor Andrew Bailey said the longer elevated energy prices persist, the more difficult the situation becomes.
However, the Bank has so far found relatively limited evidence that the energy shock is creating substantial secondary increases in prices and wages throughout the economy.
That helps explain why a majority of policymakers chose to leave interest rates unchanged rather than increase them immediately.
For households, however, the effects of changing expectations can appear before the Bank actually changes its official rate.
Fixed mortgage pricing is influenced by financial market expectations about future interest rates, meaning lenders can increase or reduce mortgage rates in anticipation of future Bank of England decisions.
The outlook could therefore be particularly important for homeowners approaching the end of fixed-rate mortgage deals.
Prime Minister Andy Burnham took office in July promising measures intended to give households greater financial "breathing space".
Early measures included removing VAT from household electricity bills and restoring a £2 cap on bus fares.
But global energy prices are creating economic pressures largely outside the government's direct control.
Higher petrol, domestic energy and business costs can increase inflation and reduce household purchasing power, while persistently high inflation makes it more difficult for the Bank of England to reduce borrowing costs.
The Bank's September decision illustrates that tension.
Six members concluded that keeping rates at 3.75% was appropriate while more evidence emerged about how higher energy prices were affecting the wider economy.
Three members – Megan Greene, Catherine Mann and Huw Pill – instead supported increasing Bank Rate to 4%.
They argued that the duration of the Middle East conflict and higher energy and food prices had increased the danger of inflation becoming more persistent.
There are nevertheless competing pressures facing policymakers.
The labour market remains relatively soft and higher borrowing costs are already restraining spending by households and businesses, factors which should help reduce inflation over time.
If geopolitical tensions ease and energy prices fall, the inflation outlook could improve relatively quickly.
If high energy prices persist, the risk of further monetary tightening becomes greater.
The Bank has therefore stopped short of committing to its next move, saying future decisions will depend on the scale and duration of the energy shock and how it feeds through into prices, wages and the wider economy.
The next scheduled Bank of England interest-rate decision is in November.