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The Bank of England has held interest rates at 3.75 per cent but signalled it may need to increase borrowing costs in the coming months if the Iran war energy shock continues to batter the global economy.
The Monetary Policy Committee voted eight to one to keep the UK central bank’s key rate unchanged for the third consecutive meeting.
Huw Pill, BoE chief economist, backed an immediate quarter-point rate rise to mitigate “upside risks to price stability”, according to minutes of the meeting published on Thursday.
The BoE was forced in March to ditch its previous plans to continue lowering rates as the US-Israeli attacks on Iran prompted the effective closure of the Strait of Hormuz and sent oil prices surging.
With oil surpassing $125 on Thursday, central bankers are increasingly fearful that the prolonged disruption to energy supplies will feed into wider wage- and price-setting.
In a statement after the meeting, BoE governor Andrew Bailey said holding rates at 3.75 per cent was a “reasonable place given the situation of the economy and the unpredictability of events in the Middle East”.
He added: “We’ll continue to monitor the situation and its impact on the UK economy very closely. Whatever happens, our job is to make sure that inflation gets back to the 2 per cent target after the initial impact of the war on energy prices has passed.”
The pound was little changed as the MPC’s decision and the vote split were in line with expectations. Sterling was up 0.4 per cent against the dollar on the day at $1.352.
The chance of a quarter-point interest rate rise at the MPC’s next meeting in June fell to roughly 50 per cent, according to the probability implied in derivative contracts, from about 70 per cent before the decision.
The minutes to the April meeting pointed to a heavily divided MPC, with some members saying they would like to “act early” to prevent inflation getting out of hand, while others awaited more conclusive evidence of inflationary dangers before changing policy.
The MPC reiterated that it “stands ready to act as necessary” to keep inflation on track to meet the 2 per cent target. Inflation accelerated to 3.3 per cent in March, led by a surge in petrol prices, according to official data.
Given the uncertainty about the outlook for the Gulf conflict, the BoE ditched its customary central forecast and set out three scenarios for how the impact of the war might pan out.
Under Scenario A, the energy shock will be shortlived, meaning it does not pass through into wider prices and wages. The BoE might be able to keep rates unchanged, although some tightening could be needed depending on how the economy evolves.
Scenario B — on which Bailey said he put the most weight — points to “higher and more persistent” energy costs, as does Scenario C.
Scenario B implies there may need to be at least two increases in interest rates in the coming year, in line with market expectations when the BoE prepared its outlook.
Scenario C suggests higher energy costs feed more widely into the economy, requiring a “forceful tightening” that would take rates as high as 5.25 per cent, equal to levels seen after the last inflation shock.
All of the scenarios suggest inflation will be 3.3 per cent or higher this year, compared with just 2.2 per cent projected in February.
The economy will grow by 0.7 per cent or 0.8 per cent this year, the BoE said, while skirting a technical recession under all three scenarios. Unemployment is set to rise from 5.1 per cent this year to at least 5.5 per cent.
Additional reporting by Ian Smith in London
