Bank of England Expected to Hold Rates Despite Rising Inflation

The Bank of England is widely expected to leave interest rates unchanged on Thursday, despite inflation rising well above its 2% target.

Markets are pricing in more than an 80% chance that the central bank will hold interest rates steady on Thursday, according to LSEG data, but a hike of at least 25 basis points is widely anticipated at its next meeting in November.

A hold would mark a divergence from other major central banks. The U.S. Federal Reserve announced a quarter-point hike on Wednesday, its first hike since 2023. Last week, the European Central Bank announced its second rate hike this year, after raising rates in June for the first time in three years. The Bank of Japan is expected to raise its key interest rate at the end of its two-day meeting on Friday.

The Bank of England has not altered its key interest rate this year. It last changed rates in December, with a 25-basis-point cut.

Data released Wednesday showed that the U.K.'s inflation rate rose to 3.1% in August, marking its first rise above 3% since March.

The country's Office for National Statistics (ONS) said the spike was largely driven by rising motor fuel costs, which surged 23% year-on-year.

As a net energy importer, the U.K. is particularly vulnerable to external energy shocks, and is still grappling with a cost-of-living crisis brought on by post-Covid inflation and the Russia-Ukraine war's impact on natural gas supplies.

Global inflation concerns, political instability and apprehension about U.K. fiscal policy have put pressure on British government bonds, known as gilts, this year. Britain has the highest borrowing costs in the G7, with yields on its long-dated 20- and 30-year gilts approaching the 6% mark.

Earlier this week, British newspaper The Telegraph reported that the Bank of England would announce plans to stop selling 20- and 30-year gilts alongside its interest rate decision.

Although the inflation increase was "unlikely to convince the Bank of England to hike interest rates just yet," it could raise fresh concerns about the outlook for inflation among policymakers, said Scott Gardner, an investment strategist at J.P. Morgan Personal Investing.

"The U.S.-Iran conflict began over six months ago but higher energy costs are still filtering through to business input prices and household spending," he said in a note Wednesday.

Shreyas Gopal, an FX strategist at Deutsche Bank, said in a Wednesday note that the absence of any materially hawkish surprises in both this week's U.K. labor market and inflation data had been "enough for pricing for [hikes at] this upcoming meeting to fall back again."