Bank of England Warns Inflation Will Rise This Year as Policymakers Split on Rate Hike

The Bank of England left interest rates unchanged at 3.75 per cent today, holding steady even as a fresh rise in energy prices raised concerns about a renewed inflation shock.

The Monetary Policy Committee backed the decision by a 6-3 majority, marking the fifth consecutive meeting at which Bank Rate has been kept at its current level.

Bank of England Governor Andrew Bailey said the move was “appropriate as global conditions look to be more uncertain and inflationary”.

However, three members of the MPC pushed for a quarter-point increase, voting to lift interest rates to 4 per cent.

In an unexpected shift, rate-setter Catherine Mann changed position and supported an immediate rise to 4pc, joining fellow MPC members Huw Pill and Megan Greene in calling for tighter monetary policy.

Mann cited the “collapse” of the US-Iran peace deal, the “widening of the Middle East conflict” and the resulting “associated volatility in energy prices” as reasons behind her vote for a rate hike.

The Bank now expects inflation, currently running at 2.6 per cent, to reach 3 per cent later this year as household energy bills climb under the Ofgem price cap.

Its central forecast includes the recent announcement by new Prime Minister Andy Burnham to cut VAT for pubs and restaurants and impose a nationwide £2 bus fare cap to ease cost-of-living pressures on households and businesses.

But in the Bank’s worst-case scenario inflation will top 4 per cent next year if oil prices go over $100 a barrel. Brent crude currently trades at around $82.

The Bank expects economic activity to ‘weaken slightly’ in the next few quarters, with ‘subdued’ growth of just 1.1 perc ent this year.

Unemployment – currently at 4.8 per cent – is forecast to rise ‘gradually’ to 5.1 per cent by the end of the year, mainly because of ‘continued weak hiring’ by employers rather than job losses. 

Oil prices could drive higher inflation 

The recent resumption in hostilities in the Middle East has pushed oil prices to their highest level in months, with Brent crude hitting $100 a barrel last week. 

While prices are now back below $90, there are fears that the prolonged closure of the Strait of Hormuz could prompt another bout of higher inflation, with mortgage lenders already raising rates in anticipation.

Inflation fell by more than expected in June to 2.6 per cent, but core and services inflation stayed relatively level. Meanwhile, private sector wage growth has fallen to a six-year low.

When oil prices hit as high as $126 a barrel earlier this year, economists warned that inflation could reach 5 per cent by the summer. 

The Bank of England said it expects the headline rate to rise later this year ‘as the effects of higher energy prices continue to pass through.’ 

Governor Andrew Bailey said: ‘Events in the Middle East mean that the short-run path of inflation is uncertain owing to volatile energy prices. 

‘The possibility of repeated resumptions of conflict, combined with lower than usual European gas stock levels and a fall in global refining output, mean that risks to energy prices lie to the upside. 

‘Set against that, the process of underlying disinflation that was intact prior to the conflict remains in train.’

The Bank expects higher energy prices to add around 0.4 percentage points to CPI in the second half of the year, while higher petrol prices will add 0.3 points. 

Food inflation is projected to rise to 3.5 per cent by the end of the year, with headline inflation expected to average 3.2 per cent in the final quarter. 

Central banks typically raise rates to bring down inflation and cut them once prices are back under control.

The fall in the headline inflation rate provides rate setters with enough cover to continue their ‘wait and see’ approach. 

That is better news for millions of households and businesses concerned about a sharp increase in the cost of their mortgages and other loans this summer.

Where will interest rates go next? 

Markets are pricing in a single, one-quarter-point rate rise to 4.00 per cent for this year and two more to 4.50 per cent by this time next year. 

Fixed-rate mortgage costs, which are set by financial market expectations, have already crept higher since the Gulf conflict resumed, dampening demand in the economy.

‘Financial conditions have tightened since the onset of the conflict,’ Bailey said.

‘Inflation has fallen faster than we’d expected,’ he added. ‘But the conflict in the Middle East continues to mean high and volatile energy prices. That will cause inflation to rise again later this year.’

Britain’s biggest lender expects one rate cut later next year.

‘The MPC is most likely to be in wait-and-see mode for the rest of the year,’ Lloyds Banking Group finance director William Chalmers said.

Richard Carter, head of fixed interest research at Quilter Cheviot added: ‘The Monetary Policy Committee next meets in September, and a rate rise could be possible by then. 

‘However, complicating matters somewhat is the expected Budget from John Healey at some point in the Autumn. 

‘With cost-of-living measures expected to be front and centre of this, as well as additional spending commitments looking likely, it may be the BoE sticks to its holding pattern before acting, offering a level of policy stability that is craved right now.’ 

Yesterday, the Federal Reserve held rates at 3.5 per cent,  but officials were split over how to tackle inflation, with three officials backing a rise. 

Fed chair Kevin Warsh, who took over in May after being appointed by President Donald Trump, said there had been ‘vigorous discussions’. 

This is a developing story