The Bank of England's Monetary Policy Committee voted to hold interest rates at 3.75% on Thursday, citing the Middle East conflict as the primary risk to inflation. The decision comes despite stable domestic prices and a CPI inflation rate of 2.6% in June.
Underlying Inflation Pressures Largely Absent
Senior UK central bankers believe that without the war, inflation would be rising steadily at the 2% target. The MPC noted that underlying pressures on inflation are almost entirely absent in the domestic economy. Prices remain stable, and the conflict is the key factor that could push inflation back onto a rising trajectory.
The Bank's quarterly review states: "So far, there are few signs of second-round effects. But there is not enough evidence yet to rule out this risk, and the MPC will continue to monitor evidence closely."
Wage Growth and Corporate Pricing Remain Muted
Annual wage increases in the private sector are low, at 2.8% in the second quarter of 2025, expected to rise to 3% in the third quarter—a level Bank officials are comfortable with. There is no evidence of companies capitalising on rising prices across manufacturing, construction, or services industries.
The three MPC members who voted for a rate increase acknowledged that neither workers nor firms have reacted to inflation yet. However, they argued that once prices begin to rise again due to the conflict, workers and companies would likely embed inflationary pressures into the economy.
Labour Market and Financial Conditions
The majority on the MPC focused on the labour market, noting a rise in unemployment and a sharp fall in vacancies over the last three years. Financial markets have already tightened conditions by raising mortgage and commercial lending rates, impacting homebuyers and firms without the Bank needing to act.
Businesses seeking to invest and hire could benefit from lower interest rates, but the Middle East crisis stands in the way.
Inflation Forecasts and Economic Impact
The Bank's forecasters expect inflation to peak at 3.2% next spring, but warn it could reach 4.1% if the war persists and Brent crude prices exceed $100 a barrel. The National Institute of Economic and Social Research reported that the UK has already lost £28 billion in growth this year due to the conflict.
The Bank warned that if the war continues, it might need to raise rates, which would severely impact businesses, consumers, and mortgage borrowers.
