The Bank of England (BoE) Monetary Policy Committee (MPC) decided to increase the policy rate by a quarter point (25 basis points) to 4 percent.
While the decision was taken by a majority vote of 8-1, external member Catherine Mann voted to increase interest rates by half a point to 4.25 percent.
In the text explaining his decision, BoE Governor Andrew Bailey said, "I can see the argument for further interest rate hikes and then adopting a more conditional approach."
"Today's increase should not be viewed as the first in an inevitable and long series of rate hikes. However, it does not appear to be the last increase unless the conflict in the Middle East is resolved," Bailey said in a prepared statement.
British households are already experiencing a sharp squeeze on living standards due to high energy and fuel costs. Energy bills are expected to increase by 25 percent in January, when the regulated ceiling price will be reset, and an additional increase is expected in April.
The BoE predicts that consumer price inflation (CPI) will reach its highest level since September 2023, at 4.9 percent in the second quarter of next year. Under an assumed interest rate path with a peak between 4.75 percent and 5 percent, inflation is expected to fall below the 2 percent target in 2029; This indicates that only one or two more rate hikes may be necessary. In its previous set of forecasts in July, the BoE predicted inflation would peak at just 3.2 percent.
Iran war and risks of second-round impact
In the bank's downside scenario, which includes repeated escalations of the Iran conflict, CPI is forecast to reach 6.2 percent in the third quarter of 2027. Even in the mild scenario without second-round effects, inflation reaches 4.8 percent by early next year, largely due to the January increase in the household energy cap price.
The bank emphasized that it took early action to prevent the risk of high costs affecting the wage and price determination processes. While there has been little evidence of second-round effects so far, the Committee said it feared these effects would emerge when businesses' "hedging and long-term fixed-price contracts" expire.
External MPC member Alan Taylor, one of the most dovish members, described the move as "a temporary insurance increase for risk management purposes". Vice President of Markets Dave Ramsden wrote that "less favorable initial conditions increase the risk of a second-round impact." With energy prices well above previously anticipated levels, the MPC changed its verbal guidance, stating that it would "continue to consider the evidence at each meeting, particularly the possibility of higher energy prices being reflected in other prices and the broader economy." The committee added that it would monitor second-round impacts on "base wages, pricing behavior and idle capacity" and that the policy was "not on a predetermined path".
Revision in growth forecasts
The UK economy performed more resiliently than expected. The MPC said that while "policy was still restrictive" before Thursday's rate hike, "it is less clear whether this will create enough disinflationary pressure to bring inflation back to target in time." BoE increased its GDP growth forecast for this year from 1.1 percent to 1.6 percent and its 2027 forecast from 1.1 percent to 1.3 percent. However, assuming that the impact of the energy shock will continue, it reduced its 2028 expectation from 1.7 percent to 1.2 percent. In the "weak demand" scenario, it was predicted that inflation would fall sharply to 1.2 percent and interest rate cuts would be needed.
Additionally, the BoE estimated that Chancellor of the Exchequer John Healey's budget would reduce inflation by 0.25 percentage points in the second quarter of next year; This figure indicates a larger impact than the budget watchdog predicted.
