The Bank of England is grappling with a challenging decision on whether to adjust interest rates as the ongoing conflict in the Middle East continues to drive up prices, according to the Governor of the Bank, Andrew Bailey.

Bailey highlighted that a significant energy shock is likely to increase financial pressure on UK households. However, he emphasized that the central bank would exercise caution and not rush into making a decision regarding potential interest rate hikes.

During an interview with the BBC at the International Monetary Fund (IMF) summit in Washington, Bailey explained that while rising oil and gas prices are expected to affect overall prices, several other factors complicate the decision-making process.

Prior to the outbreak of the conflict, there was widespread anticipation that the Bank of England might lower interest rates this year, as indicators suggested a cooling labor market and a decline in inflation.

However, the recent oil supply shock has significantly altered market expectations, with many now anticipating that interest rates may either remain unchanged or even increase within the year.

This potential shift poses a risk to an economy already burdened by sluggish growth and high unemployment rates, raising concerns about the broader economic impact.

‘There’s really difficult judgments to be made,’ he said. ‘We’re not going to rush to judgments on those things, because there are a lot of uncertainties around this, not just how it’s going to play out, but also how it’s going to pass through into the UK economy.’

The IMF slashed its growth forecast for the UK this year to 0.8 per cent – the biggest downgrade of all G7 nations – as it warned the global economy could face a recession if oil stays above $100 a barrel through next year.

And on Wednesday, the IMF warned central banks should not rush to hike interest rates to head off rising inflation – Bailey said he was taking into account the ‘serious advice’.

The Bank’s Monetary Policy Committee will meet at the end of this month, with traders expecting interest rates to stay at 3.75 per cent.

At its last meeting, when the BoE held rates, Bailey said the financial markets were getting ahead of themselves in expecting rate hikes.

Economists agree and say conditions in the UK today are different from when Russia invaded Ukraine, which sent energy prices soaring. 

In 2022, inflation stood at more than 6 per cent while the Bank rate stood at 0.5 per cent, compared to 3.75 per cent today.

There are concerns, however, that the damage caused by the war is somewhat baked in with higher inflation expected in the second half of the year and slower growth.

Figures published by the ONS today showed an unexpected jump in GDP growth in February, but experts warn that 

‘Even before the war, we doubted that the economy could enjoy a sustained acceleration,’ said Andrew Wishart, senior UK economist at Berenberg. 

‘Flat employment, decelerating pay growth and a rising personal tax burden were set to reduce real household spending power. 

‘Now we can add higher energy prices and mortgage interest rates to the list of headwinds.’ 

He added: ‘The new energy price shock means the UK must now endure both weaker growth and higher inflation, postponing bank rate cuts but not derailing them.’ 

Bailey warns of financial meltdown 

In a letter to the IMF’s main steering committee, the Bank of England Governor warned of threats to financial stability that chimes with 2008. 

Bailey pointed to elevated share prices, stresses in the private credit markets and liqudiity issues. 

‘Put simply, there is an increased likelihood that multiple vulnerabilities could crystallise at the same time, thereby amplifying the threat to financial stability and the provision of critical financial services,’ Bailey said. 

It echoes the Bank’s comments earlier this month, warning that the Middle East conflict threatened to increase instability in the financial system. 

Cautioning against dismissing recent private credit failures, Bailey said there could be ‘a wider loss of confidence, reminiscent of the 2008 financial crisis’.