The Bank of England has warned that interest rates are likely to rise if the Middle East war continues, as the central bank's governor stated inflation is on course to hit 4pc. Andrew Bailey delivered the warning while the Monetary Policy Committee voted six to three to hold Bank Rate at 3.75pc on Thursday, marking the sixth consecutive meeting without a change. The decision leaves the Bank out of step with the US Federal Reserve and the European Central Bank, both of which raised borrowing costs this month.
Bailey attributed the upward pressure on prices to a material increase in energy costs since July, noting that oil prices have returned above $100 a barrel. He told Chancellor John Healey that energy bills are expected to rise by 24pc under the Ofgem price cap, pushing annual average bills to £2,136. Official data showed inflation reached 3.1pc in August, well above the Bank's 2pc target.
The governor acknowledged that higher global energy costs have had a limited effect on UK price and wage setting so far. However, he cautioned that prolonged volatility would increase the impact on inflation, making it more likely the Bank would need to raise Bank Rate to ensure prices fall back to target. Three members of the committee, Megan Greene, Catherine Mann, and Huw Pill, voted to increase rates to 4pc, citing the escalation and duration of the conflict as key drivers of rising energy and food prices.
Markets reacted to the meeting with a rally in UK equities. The FTSE 100 climbed more than 1pc, its steepest pace since July, as investors interpreted the committee's stance as less hawkish than feared. The average five-year fixed mortgage rate had previously risen to 5.87pc, its highest level since November 2023, driven by expectations of future rate hikes. Economists at Capital Economics scrapped their forecast of no rate increases this year, suggesting a majority of the committee is on the cusp of wanting to tighten policy if energy prices do not fall back.
In a separate move, the Bank announced it will stop selling long-dated government bonds amassed during the financial crisis and lockdown. Officials will hold £120bn of these long-dated gilts permanently in their portfolio to back banknotes. The announcement triggered a sharp fall in borrowing costs for the Treasury, with the yield on 30-year UK gilts dropping at its fastest pace since May. The pound fell slightly against the dollar after the decision, as traders scaled back bets on multiple rate rises over the coming year.