Bank of England holds rates at 3.75% but warns of hikes if energy costs persist

The Bank of England has maintained its benchmark interest rate at 3.75% for the sixth consecutive meeting, although it has signalled that further increases are likely if elevated energy prices continue. Governor Andrew Bailey stated that the volatility in energy markets makes it more probable that monetary policy will need to tighten. This decision comes against a backdrop of disrupted global energy supplies resulting from the conflict between the US, Israel and Iran, which has driven up petrol and diesel prices and contributed to a rise in inflation.

Inflation in the United Kingdom has remained above the central bank’s target of 2% for nearly two years, reaching 3.1% in August. The Bank of England has now raised its forecast, predicting that inflation will be slightly above 4% at the start of next year. Officials warned that the price cap on household gas and electricity bills for January is expected to rise substantially. While the direct impact of higher energy prices is clear, the Bank is still assessing the extent to which these costs will feed through into wider economic inflation. Bailey noted that for interest rates to eventually fall, there would need to be an end to the conflict in the Middle East and a return of energy prices to pre-conflict levels.

The decision to hold rates was not unanimous. Of the nine members on the Monetary Policy Committee, six voted to keep the rate at 3.75%, while three, including chief economist Huw Pill, advocated for a rise to 4%. This stance contrasts with other major central banks that have recently increased rates to counteract higher prices. The US Federal Reserve announced its first hike in three years on Wednesday, and the European Central Bank has raised rates twice since June. Despite the current hold, financial markets have priced in the possibility of several rate rises next year, although Bailey described the global backdrop as hugely unpredictable.

Alongside the interest rate decision, the Bank of England announced it would slow its sales of UK government debt. It will pause its annual quantitative tightening programme, which involves offloading bonds bought during periods of economic turbulence such as the global financial crisis and the pandemic. Instead of selling the current stockpile of £488bn in one go, the Bank will sell smaller chunks over eight years. This move prompted an immediate reaction in financial markets, with the yield on 30-year UK government bonds falling from 5.86% to 5.75% following the announcement. Yields on 10-year bonds also dropped from 5.31% to 5.22%. The Bank stated that discussions to restructure this programme began a year ago, implying the decision was not a direct response to recent rises in long-term borrowing costs.

The Bank also offered some positive assessments of the UK economy, describing it as more resilient than previously expected. It raised its prediction for economic growth from 0.1% to 0.4% for the period between July and September. Furthermore, because the effect of higher energy costs has not yet spilled over into other areas, food price inflation is now predicted to be 4% by the end of the year, lower than the previous forecast of 6% to 7%.

However, the decision to hold rates and market expectations of future hikes have already impacted the mortgage market. Major lenders have increased the cost of new fixed-rate mortgages. According to financial information service Moneyfacts, the average two-year fixed residential mortgage rate is at its highest since May, standing at 5.77%. The average five-year rate is at its highest since November 2023, at 5.83%. For borrowers coming off fixed deals, such as Andy Pargeter from Flintshire, the steady rates mean higher monthly payments. Pargeter, whose five-year fixed rate of 1.19% ends in November, expects to pay around £300 more a month, which he says will affect his family’s ability to save.