Key Takeaways:
The Bank of England kept its benchmark rate at 3.75% Thursday, but a three-way dissent for a hike and a forecast for inflation to peak at 3.2% this year pushed markets to price in 39 basis points of additional tightening by December.
The Bank of England held rates at 3.75% Thursday but a three-way dissent for a quarter-point increase and a higher inflation forecast pushed traders to price in 39 basis points of tightening by year-end.
"The situation is extremely fluid, and the risks certainly are we do indeed see a rate hike this year," said Ellie Henderson, economist at Investec. "However, for now, the MPC are basing their decision off the fact policy is already in restrictive territory."
The Monetary Policy Committee voted 6-3 to keep Bank Rate unchanged, with external members Megan Greene and Catherine Mann joining Chief Economist Huw Pill in favoring a 25-basis-point increase. The BoE's new forecasts show consumer price inflation peaking at 3.2% in the fourth quarter of 2026, above its 2% target and up from the 3.25% peak projected in June.
The hawkish hold leaves new Prime Minister Andy Burnham, who has pledged to lower living costs and scrapped a tax on household electricity bills this month, facing the prospect of higher borrowing costs. The next MPC decision is scheduled for September, when markets now see a two-in-three chance of a quarter-point increase.
The vote split shows deepening concern on the committee about persistent price pressures, even as headline inflation fell to a 15-month low of 2.6% in June. Britain's inflation has remained above the BoE's 2% target for most of the past five years, and the recent spike in oil prices above $100 a barrel — driven by the Iran conflict and the closure of the Strait of Hormuz — has reignited fears of a second energy price shock.
Governor Andrew Bailey has argued the BoE does not need to follow the European Central Bank, which raised rates in June, because it had cut less before the Iran war began in late February. British mortgage rates and corporate borrowing costs rose almost immediately after the BoE signaled in March that previously expected rate cuts for 2026 were off the table.
Inflation Outlook Diverges From Market Pricing
While the BoE's central forecast sees inflation peaking at 3.2% this year, rate futures markets point to a more aggressive path. Traders are fully pricing in a quarter-point hike by November and another by March 2027, according to overnight index swap rates. That contrasts sharply with the view of most economists: a Reuters poll published last week found 58 of 70 respondents expect no change through the end of 2026.
"The BoE has had three downside surprises in a row on inflation and plenty of signs of slack within the labor market," said Henry Cook, senior economist at MUFG, who scrapped a previous call for a precautionary rate rise. Private-sector wage growth slowed to 2.9% in the three months through May, the weakest since 2020.
The BoE also published an analysis of how its bond sales program affects markets, ahead of an annual MPC vote on the pace of quantitative tightening in September. Markets expect the central bank to slow the pace to 50 billion pounds a year from the current 70 billion pounds, after research suggested the sales have added as much as 0.4 percentage points to long-term gilt yields.
The last time the BoE faced a similar three-way dissent was in June, when Pill also voted for a hike. That precedent, combined with the upward revision to the inflation forecast, suggests the pressure on the majority to act will only intensify if energy prices remain elevated through the autumn.
The next MPC meeting is scheduled for September, when the vote on QT pace and the rate decision will test whether the majority's patience with elevated inflation has limits.
This article is for informational purposes only and does not constitute investment advice.
