The Bank of England increased its base interest rate to 4% on Wednesday, marking the first rise in more than three years. The move was driven by soaring inflation linked to the ongoing war in Iran. Eight members of the monetary policy committee voted for the 25 basis point increase, while the ninth member, Catherine Mann, favored a more aggressive half-point hike.
The conflict in the Middle East has kept oil prices persistently above $100 per barrel in recent months. This trend emerged as hopes for a deal to reopen the Strait of Hormuz faded. Consequently, the Bank has revised its inflation forecasts upward, now predicting that UK inflation will reach 4.9% by mid-2027. This is a significant jump from the 3.2% projected in its July forecast. Actual inflation had already hit 3.5% in September, according to the consumer prices index.
Governor Andrew Bailey indicated that further rate increases are possible in the near future. He stated that the resolution of the Iran conflict is the critical factor that will influence the Bank's next steps. In the committee minutes, Bailey noted that without news softening the risks to inflationary pressures, there is a strong argument for raising rates again before taking a more conditional approach.
Bailey cautioned against viewing the current hike as the start of a long, inevitable sequence of increases. However, he acknowledged that unless the Middle East conflict is resolved, it is unlikely to be the last rate rise. The Bank's next decision on interest rates is scheduled for 17 December.
Market dynamics have shifted recently as oil prices dropped below the $100 mark following Democratic victories in the US Congress. Some investors interpreted these results as a potential constraint on President Donald Trump's ability to prolong the conflict. Vice President JD Vance attributed the political rout to the war and its impact on inflation.
The committee explained that elevated oil prices are passing through to business and consumer costs across the economy. The Bank expects the Ofgem energy cap for Great Britain to rise to 2,150 pounds in January, with another increase planned for April. Food price inflation could also reach 4.75% by mid-2027, the MPC warned.
While businesses have so far managed to absorb soaring energy costs through hedging, the committee believes they will soon need to pass these costs on to consumers through higher prices. Additionally, the Bank is concerned about workers bidding for significant pay rises to offset the higher cost of living.
Although the decision to raise rates was unanimous, the minutes revealed distinct divisions regarding the magnitude of future moves. Alan Taylor, a member with dovish views, suggested the current hike should be treated as a one-off risk-management measure. In contrast, Catherine Mann argued that an immediate half-point increase was necessary to restore the Bank's credibility in fighting inflation.
The rate hike comes just one week after Chancellor John Healey presented his first budget, which promised breathing space for consumers. Healey's package included measures to cushion the impact of higher energy prices, such as extending the fuel duty freeze and cutting VAT on electricity bills. The MPC estimated that these measures would reduce inflation by a quarter of a percentage point by mid-2027.
The Bank also warned that real post-tax income is expected to fall this year and next, echoing the gloomy living standards forecasts from the Office for Budget Responsibility. This decline highlights the continued pressure on household finances despite the government's recent fiscal interventions.
