Bank of England Set to Hold Rates at 3.75% as Oil Surge Clouds Outlook

The Bank of England is expected to leave interest rates unchanged at 3.75% this week, even as a sustained climb in oil prices complicates its outlook, while also slowing the pace at which it runs down the government bond portfolio built up between 2009 and 2021.

Governor Andrew Bailey said last week that the central bank had no "secret plan" to raise rates this year unless the oil rally, driven by the war in the Middle East, fed into more durable domestic price pressures. Economists surveyed this month unanimously expected a hold in September, with most judging the next move more likely to be a cut next year than a hike.

Yet with crude trading above $100 a barrel — broadly in line with the most adverse of three scenarios the bank sketched in July — some analysts are less certain. Barclays interest rate strategist Moyeen Islam wrote that a surprise quarter-point increase "cannot and should not be ruled out" given the speed of the oil move and firmer central bank rhetoric.

Markets assigned roughly a 30% probability to a quarter-point hike at the September 17 decision, up from under 10% at the start of last week, and were close to fully pricing in a November move. Bailey has said he wants clearer evidence that higher energy costs could trigger substantial pay deals or broad-based price increases before supporting a rise.

Few economists expect a change this month from July's 6-3 split on the Monetary Policy Committee. Chief Economist Huw Pill, Megan Greene and Catherine Mann backed an immediate quarter-point rise to 4.00%, with Mann switching from the hold camp the previous month — a hawkish drift that has widened at each meeting since March. ING economists James Smith and Michiel Tukker said they did not expect the committee to turn materially more hawkish, in contrast to the European Central Bank this month.

Bond unwind in focus

The committee will also cast its annual vote on the pace of quantitative tightening. Since the bank stopped reinvesting maturing gilt proceeds in February 2022, its holdings have fallen by more than £400 billion, about a third of that through active sales — a route the Federal Reserve and ECB have not taken.

Last September the bank slowed the unwind to £70 billion a year from £100 billion, and a July investor survey pointed to a further reduction to £50 billion for October 2026 to September 2027. The smaller figure largely reflects fewer gilts maturing, while sales under that scenario — £19.5 billion — would be only slightly below the £21 billion sold over the past 12 months.

Deputy Governor Dave Ramsden told lawmakers last week that central bank research pointed to a cumulative 25 basis-point upward effect on gilt yields from the programme, indicating it was working as intended. Estimates differ, however: Morgan Stanley strategist Fabio Bassanin said that figure probably held for 10-year gilts, but for 30-year gilts the impact looked closer to 70 basis points — roughly the gap between 30-year British and U.S. borrowing costs.

Prices of 20- and 30-year gilts fell to their lowest since 1998 last week, and further sales would lock in those losses. The bank skewed sales away from long-dated gilts last year, and Deutsche Bank expects it to halt them entirely. Analysts also want guidance on the programme's longer-term future. Bailey wants to remove the interest rate risk the holdings create, while some observers argue for retaining some gilts permanently. Deutsche Bank Chief UK Economist Sanjay Raja said the debate should shift from how quickly the balance sheet shrinks to what its long-run structure should be.