Bank of England Holds Rates at 3.75% but Signals Hikes as Inflation Set to Top 4%

The Bank of England left its benchmark interest rate unchanged at 3.75% on Thursday, but its latest policy minutes struck a markedly more hawkish tone, warning that borrowing costs may need to rise if the conflict with Iran continues to push up energy prices.

The Monetary Policy Committee voted 6-3 to hold the Bank Rate, matching both its previous split and the median expectation of economists. Chief Economist Huw Pill and external members Megan Greene and Catherine Mann again backed an immediate quarter-point increase to 4%.

Crucially, Governor Andrew Bailey and his deputies Sarah Breeden, Clare Lombardelli and Dave Ramsden all indicated they could support a hike in future, a shift that analysts said leaves the door open to tighter policy.

Bailey said the central question — whether the energy price surge feeds into broader inflation — remains unresolved. He noted that pass-through into wages and business pricing has so far been subdued, but cautioned that it is early and that the longer the conflict drags on, the harder the trade-offs become. Asked about market pricing of almost four quarter-point hikes over the coming year, he said the outlook was too uncertain to judge.

The Bank said inflation risks have tilted further to the upside since its July forecasts, with the recent move in energy prices bearing similarities to its adverse scenario in which inflation becomes entrenched. It now expects inflation, which stood at 3.1% in August, to reach slightly over 4% in early 2027 — more than double its 2% target and well above its previous peak forecast of 3.2% in late 2026. Inflation has exceeded target in all but three months over the past five years.

In a hardening of its language, the committee said that given the lags with which second-round effects appear, it would not be appropriate to wait too long for evidence before responding.

The Bank also raised its estimate for third-quarter economic growth to 0.4% from 0.1%. The warning comes as Prime Minister Andy Burnham and finance minister John Healey seek to project economic confidence ahead of the budget on October 28.

Separately, the Bank announced a surprise six-month pause on active sales of government bonds and set out a longer-term overhaul of how it unwinds its gilt holdings. Under the plan, the MPC will aim to reduce its monetary-policy gilt stock to zero by 2034, retaining only long-dated gilts needed to back banknote issuance. Gilts maturing between 2035 and 2049 will be sold back to the government, with full details due before April 2027, while shorter-dated gilts due before 2035 will be held to maturity. The changes effectively leave the Debt Management Office in full control of gilt issuance to the secondary market.

Sterling fell by around half a cent against the dollar and gilt yields dropped sharply after the decisions. Suren Thiru of the Institute of Chartered Accountants in England and Wales described rates as being at a critical cliff-edge moment, saying persistent US-Iran hostilities have turned the risk of a hike from a possibility into a probability. Dani Stoilova of BNP Paribas said the absence of material relief in energy prices before the next meeting reinforces expectations of an insurance hike in November.

The Bank of Japan is expected to raise rates on Friday, as the spreading Middle East conflict adds to global inflation pressures.