Bank of England Holds Rates at 3.75% but Warns Inflation Could Top 4%

The Bank of England left its benchmark interest rate unchanged at 3.75% on Thursday, but struck a markedly more hawkish tone, warning that British inflation could climb above 4% early next year and that prolonged conflict in the Middle East may force tighter policy.

The Monetary Policy Committee voted 6-3 to hold rates, with three members preferring an increase to 4% — matching the median expectation in a poll of economists. Chief Economist Huw Pill and external members Megan Greene and Catherine Mann backed the quarter-point rise.

Governor Andrew Bailey said that while higher global energy costs have so far had only a limited effect on UK price and wage setting, that could change. "The longer this volatility persists, the bigger the impact it will have on inflation, and the more likely it is we will need to raise Bank Rate to ensure that inflation falls back to our 2% target," he said.

The minutes of this week's meeting showed a clear shift in tone. The Bank said inflation risks had tilted further to the upside since its July forecasts, and that the recent move in energy prices resembled its "adverse" scenario, which could entrench inflation. It added that it would not be appropriate to wait too long for evidence of second-round effects before responding with policy.

Bailey, along with deputies Sarah Breeden, Clare Lombardelli and Dave Ramsden, raised the prospect of future rate increases in the minutes.

Inflation stood at 3.1% in August and is now projected to reach slightly over 4% in early 2027, up from a previous forecast of a 3.2% peak in late 2026. The Bank also revised up its estimate for third-quarter economic growth to 0.4% from 0.1%.

The warning complicates the messaging for Prime Minister Andy Burnham and finance minister John Healey, who have sought to project optimism about the economy ahead of the budget on October 28.

Separately, the Bank rewrote its plan for unwinding the stock of government bonds accumulated through past stimulus. It now aims to reduce gilts held for monetary policy purposes to zero by 2034, while retaining some very long-dated bonds bought to support banknote issuance. Rather than actively selling gilts across maturities, it will hold bonds maturing before 2035 until redemption and will consider selling those maturing between 2035 and 2049 back to the government, with plans to be announced before April next year. All active sales will be paused in the meantime.