Bank of England officials signal rising likelihood of rate hikes

A senior Bank of England policymaker has indicated that an increase in interest rates is becoming increasingly probable if energy prices remain elevated for an extended period. While officials maintained a cautious stance regarding the potential for UK inflation to spiral over the coming year, the tone of recent commentary suggests a shift in the monetary policy outlook. This development occurs against a backdrop where the central bank has held rates steady, distinguishing its approach from that of the Federal Reserve and the European Central Bank, which have both moved to tighten their respective policies.

Deputy Governor Clare Lombardelli, speaking at an event in Warsaw, highlighted that persistent higher energy prices make it increasingly likely that monetary policy will need to be tightened. Although she voted with the majority to keep interest rates at 3.75 per cent, Lombardelli acknowledged that the risk of energy costs pushing prices higher in the coming months has grown. She noted that while it is too early to determine if the spike in energy costs driven by the Iran conflict has become embedded in the economy and wage settlements, the trajectory is moving towards an adverse scenario outlined by the central bank’s forecasters. She emphasised that policy should not respond mechanically to energy price movements but must consider broader economic evidence.

The Monetary Policy Committee recently voted six to three to leave rates on hold, with three members including Huw Pill, Megan Greene and Catherine Mann arguing for an immediate increase. Inflation data showed a slight rise to 3.1 per cent in the year to August, with the committee projecting that price growth could exceed four per cent in the early months of 2027. Lombardelli described the relationship between rising energy prices and second-round effects, where shocks can lead to spiralling wages and prices, as positively related, though she noted uncertainty regarding how firms would respond by adjusting their own pricing.

Sarah Breeden, another member of the committee, reinforced this hawkish sentiment during a separate event in London. She stated that the balance of risks had shifted, making it increasingly appropriate for the Bank to respond to inflation risks without waiting for conclusive evidence. Breeden suggested that as risks crystallise, it becomes more suitable for Bank Rate to adjust, noting that individual committee members would reach their tipping points for action at different times. She indicated that three members had already decided they had seen sufficient evidence to support a rate hike.

Conversely, rate-setter Swati Dhingra advised caution, stating that the Bank still requires further evidence to determine if inflation will jump higher than expected. She identified the upcoming winter months as critical for observing energy price trends and finalising pay settlements. Dhingra noted that financial tightening is already under way and that current inflation increases are specific rather than broad-based, unlike the rapid spread observed during the 2022 conflict. Additionally, the OECD suggested on Wednesday that the Bank may not need to raise interest rates to keep higher inflation at bay.