Bank of England holds interest rates at 3.75% amid Iran war peace prospects

The Bank of England held U.K. interest rates at 3.75% on Thursday, as policymakers continue to balance the need to address above-target inflation with lackluster economic output.

The hold, which was in-line with the expectations of economists polled by Reuters, was backed by seven of the nine monetary policy committee members in the BOE’s May meeting.

BoE chief economist Huw Pill and Megan Greene, an external member of the rates-setting Monetary Policy Committee, were the two dissenting voices. Pill and Greene both cast votes to hike the BOE’s “base rate” by 25 basis points to 4%.

The decision comes as higher energy costs in the wake of the Iran war have pushed inflation higher in economies across the globe, and the U.K. — a net energy importer — is particularly vulnerable to price shocks.

In a summary of its decision on Thursday, the BoE said that while prices have come down since the initial spike, the war “makes it hard to predict what is going to happen with them.”

The U.K.’s own inflation rate held at a cooler-than-expected 2.8% in May, with price rises driven by rising transportation fuel costs, while data published last week showed the economy shrank by 0.1% in April.

Inflation cooled to 2.8% in April, but the drop — attributed to a change to the U.K.’s regulated energy price cap — was expected to be short-lived. The price cap is due to rise by 13% later this summer, when energy costs will hit a 2-year high.

Despite easing, the bank now expects inflation to tick higher again as energy prices carry knock-on effects to the broader economy.

“The impact on the economy and inflation will depend on how long energy prices stay raised,” it said. “Monetary policy cannot affect global energy prices; our job is to make sure that higher inflation does not persist and have long-lasting effects on the economy. We are monitoring the situation very closely,” it added.

Despite Washington and Tehran reaching a breakthrough in peace negotiations, markets are still betting that the Bank of England will raise rates by the end of the year, according to LSEG figures.

At its April meeting, the Bank of England’s Monetary Policy Committee voted to keep its key interest rate at 3.75%.

Ahead of the meeting, LSEG data showed traders were pricing in a 96% chance of the central bank keeping its key rate unchanged.

The conflict has kept oil prices elevated, thanks to the effective closure of the Strait of Hormuz, a critical oil shipping route that runs through the Middle East.

U.S. President Donald Trump and Iranian President Masoud Pezeshkian on Wednesday electronically signed a 14-point Memorandum of Understanding, aimed at laying the groundwork for a durable peace settlement to the four-month war.

It comes after the Federal Reserve also opted to keep U.S. interest rates on hold, with the federal funds rate maintained at 3.5%-3.75%, as expected. However, investors were unnerved by Kevin Warsh’s first meeting as Fed chair, with major averages swooning in response to some hawkish signals.

Last week, the European Central Bank became the first major central bank to raise its key interest rate in response to the energy crisis brought on by the Iran war. The Bank of Japan followed on Tuesday, lifting its policy rate to a 31-year high of 1%.

“We think the BoE will be able to avoid the kind of monetary tightening that the European Central Bank has already started to deliver and that the Fed hinted at last night,” said Luke Bartholomew, deputy chief economist at Aberdeen.

“In fact, if energy prices continue to moderate then the debate could once again turn again to rate cuts, but that might have to wait until next year.”

George Brown, senior economist at Schroders, said the BoE cannot afford to be complacent in the face of lingering inflation risks.

“For now, the bank is playing for time rather than going on the attack,” Brown said.

“We think the bar for hikes remains high. A softer labour market and weak growth should help limit second-round effects, and progress on reopening the Strait of Hormuz should also reduce some of the more extreme upside risks to energy prices.”

Suren Thiru, chief economist at the Institute of Chartered Accountants in England and Wales, said U.K. monetary policy now stands “at a crossroads.”

He added that the U.S.-Iran peace framework has boosted hopes that inflation could temper without the need for further tightening, but warned renewed hostilities could tilt the balance back toward hikes.