Key facts
- The Bank of England is expected to hold interest rates at 3.75% on Thursday.
- Oil prices have surged above $100 a barrel, driven by Middle East conflict.
- British inflation was at a 15-month low of 2.6% in June.
- Markets and economists are split on the outlook for future rate hikes.
- Futures markets price in a high chance of a rate hike by November.
The Bank of England is expected to maintain its benchmark interest rate at 3.75% on Thursday, despite a recent surge in oil prices above $100 a barrel, driven by conflict in the Middle East. While markets and economists largely agree on no immediate rate hike this week, there is a significant divergence regarding the longer-term outlook.
British inflation has recently fallen to a 15-month low of 2.6% in June, which is below the BoE's forecasts. This, coupled with a lag in domestic energy price responses to wholesale costs, has resulted in lower inflation in the UK compared to the US and Eurozone. However, the sustained rise in oil prices, linked to the U.S.-Iran conflict, poses a risk of testing the BoE's ability to avoid raising borrowing costs later in the year.
Financial markets are pricing in a high probability of a rate increase by November, with futures indicating a two-in-three chance of a 0.25% hike in September. Conversely, only a few economists anticipate a rate rise this year, citing recent downside inflation surprises and slack in the labor market. The BoE's chief economist, Huw Pill, has expressed concern that a second oil price shock could embed higher inflation expectations, while Governor Andrew Bailey has indicated that the BoE may not need to raise rates as aggressively as the European Central Bank due to having cut them less prior to the conflict.
The central bank is also expected to publish an analysis of its bond sales program, with potential adjustments to the pace of quantitative tightening (QT) to be considered in September.