The Bank of England (BoE) is widely anticipated to keep its interest rates unchanged at 3.75% on Thursday. This decision comes despite a recent surge in oil prices, with crude exceeding $100 a barrel, a development that could pressure the BoE to consider raising borrowing costs in response to geopolitical tensions between the US and Iran. While neither economists polled by Reuters nor financial markets foresee a rate hike this week, there's a strong divergence in expectations for the long-term outlook.
Several factors argue against an immediate rate increase. British inflation has consistently undershot the BoE's forecasts, recently hitting a 15-month low of 2.6% in June. This is also lower than inflation in the United States and the Eurozone, partly due to a lag in how regulated domestic energy prices respond to wholesale cost increases. Additionally, recent labor market data, while showing a fall in unemployment to 4.9%, still indicates slack with a five-year low in vacancies and weak survey data. Some analysts believe the current restrictive monetary policy has already sufficiently dampened inflation.
However, there are hawkish signals. BoE Chief Economist Huw Pill, who previously voted for rate hikes in April and June, has warned of the risk of a second oil price shock leading to sustained higher inflation expectations. Following the recent oil price jump, interest rate futures now imply a two-in-three chance of a quarter-point BoE rate increase by September and almost three hikes by next June. Even after oil prices dipped to $90 a barrel on Monday, markets still fully price in a rate hike by November. Governor Andrew Bailey is expected to emphasize the BoE's vigilance over wage increases and prices not directly linked to energy costs.
Adding to the complexity is the issue of quantitative tightening (QT). Last year, the BoE reduced the pace of QT to £70 billion ($93 billion) annually from £100 billion, with a survey in June suggesting markets expect a further slowdown to £50 billion. Research indicates that QT has a notable impact on long-term gilt yields, with estimates ranging from 0.15-0.25 percentage points to 0.4 percentage points. Some experts suggest the BoE might need to reconsider the pace of bond sales, as pausing QT could necessitate earlier interest rate hikes. The BoE is expected to publish an analysis of QT's market impact before a September vote on its pace. Nonetheless, Rabobank anticipates that the Bank Rate will remain at 3.75% throughout 2026, with any hike contingent on sustained high energy prices and the potential cost to a soft economy.
