Bank of England Hikes Rates to 4% as Inflation Forecast Hits 5%

U.K. inflation is projected to reach 5% by mid-2027, according to the Bank of England. The central bank raised its key interest rate by 25 basis points on Thursday to 4%, marking its first increase in more than three years. This move follows the start of a war between the United States, Israel, and Iran eight months ago. The decision made the Bank the last major central bank to begin a tightening cycle since the conflict began.

The Monetary Policy Committee approved the quarter-point hike by a vote of eight to one. The sole dissenting member preferred a 50 basis point increase, which would have set the rate at 4.25%. In its statement, the committee noted that the Middle East conflict is now in its ninth month. It observed that global energy prices have continued to rise from already elevated levels.

Governor Andrew Bailey warned in the November Monetary Policy Report that risks to inflation remain to the upside without real progress in settling the conflict. He stated that if inflationary pressures do not soften, the case for another rate increase could emerge. Bailey described any future moves as conditional on evidence regarding energy prices and inflation dynamics.

Annual inflation in the U.K. jumped to 3.5% in September, driven by surging motor fuel costs. Britain is a net energy importer, leaving it particularly exposed to external energy shocks. Markets had priced in a greater than 99% chance of a rate hike ahead of the announcement, according to LSEG data. Traders also saw a one-in-four chance of a further increase in December.

Catherine L Mann, the committee's most hawkish member, voted for the larger increase. She cited research pointing to non-linear inflation risks. Mann described her recent votes for 25 basis point hikes as a down payment to reinforce credibility. She argued the economy had entered a high inflation, tight labour market regime where a 50 basis point hike constitutes good policy.

Yields on U.K. government bonds continued to edge higher after the announcement. The benchmark 10-year gilt yield rose 2 basis points to 5.1546%, while the 2-year yield climbed 4 basis points to 4.782%. The pound was flat against the U.S. dollar and the euro on Thursday afternoon after hitting a post-Brexit high on Wednesday.

Scott Gardner, an investment strategist at JPMorgan Personal Investing, called the November hike hugely symbolic. He noted it represented a 180-degree turn from the start of the year when many believed rates would fall. Gardner pointed to accelerating goods and services inflation as a sign of second-round effects. He said the bank must balance the need for rate hikes against the risk of stunting recent positive economic growth.