The Bank of England kept its benchmark Bank Rate unchanged on Thursday and laid out three possible economic trajectories tied to the fallout from the Iran war, warning that the most damaging path could necessitate aggressive rises in interest rates.
The Monetary Policy Committee’s nine members voted 8-1 to maintain the Bank Rate at 3.75%. Only Chief Economist Huw Pill favoured an immediate increase to 4.0%, a position consistent with expectations captured in a Reuters poll of economists.
In a move that underscored the high degree of uncertainty generated by the conflict, the BoE abandoned its normal practice of publishing a single central forecast for inflation, growth and other key indicators. Instead, it presented three scenarios that depend on energy price trajectories and the extent of second-round inflation effects.
Three scenarios, different policy implications
Under the most severe scenario - Scenario C - where energy prices remain elevated for a sustained period and second-round effects materialise strongly, the BoE projected inflation could peak at 6.2%. That peak would be nearly double the most recent reading and, according to the Bank, inflation would remain above its 2% target for the next three years based on market expectations for rates at the time of the exercises. The BoE said such an outcome would be "likely to warrant a forceful tightening in monetary policy."
By contrast, the Bank said Scenarios A and B would call for a "less restrictive policy stance," noting that the increase in market-based interest rates since the start of the war would help to offset upward price pressures. The scenarios used market pricing observed in the 15 days to April 22 and did not reflect a further spike in global oil prices that took crude to a fresh four-year high earlier on Thursday amid renewed questions about the war’s duration.
Inflation drivers and labour market signals
Recent data cited by the Bank showed a rise in input costs for firms and a record jump in the share of companies expecting to raise prices over the next 12 months. The BoE also pointed to the risk of "material second-round effects" from the energy shock - for example, stronger wage demands or firms passing higher costs on to consumers instead of absorbing them.
At the same time, the Bank noted the jobs market was weakening, and that any rise in borrowing costs prompted via financial markets would itself act to help restrain inflation. The Monetary Policy Committee repeated language from its March meeting, saying it "stands ready to act as necessary to ensure that CPI inflation remains on track to meet the 2% target in the medium term."
Views inside the committee and market context
Governor Andrew Bailey said he attached the most weight to Scenario B "albeit with slightly reduced second-round effects," while also assigning "some weight" to Scenario C. Around half of the other MPC members who voted to keep rates on hold said they too leaned toward Scenario B.
The Bank noted differing preferences among committee members: some "might prefer to act early" to reduce the chance that inflation becomes entrenched at a higher level, while others could prefer to wait for clearer evidence that such a risk is crystallising.
Before the announcement, investors had priced in almost three quarter-point rate hikes for the year. The Bank highlighted Britain’s particular vulnerability to higher energy prices given the economy’s substantial use of natural gas, and market attention has focused on the country’s elevated government bond yields, which are now the highest among Group of Seven economies.
Political and fiscal backdrop
The Bank also referenced concerns about the political backdrop at home. It noted questions raised by recent political developments around Prime Minister Keir Starmer and the implications those raise for the government’s fiscal plans.
Bailey and other senior Bank officials were scheduled to hold a news conference at 1130 GMT to discuss the decision and the scenarios in more detail.
What the Bank did not change
Aside from holding the Bank Rate at 3.75%, the BoE did not return to publishing a single central forecast and elected instead to make its policy conditional on how the war and energy price developments evolve. The Bank emphasised that the scenarios were drawn from market pricing through April 22 and therefore did not incorporate the most recent spike in oil.
Chief Economist Huw Pill was the sole dissenting vote, arguing for an immediate rise to 4.0%.
The Bank’s move reflects the tension policymakers face between the inflationary impact of higher energy costs and signs of softness in the labour market. How this balance shifts as the Iran war unfolds - and how long global energy prices remain elevated - will shape whether the BoE needs to tighten policy forcefully or can rely on market-driven increases in borrowing costs to do some of that work.