Key Takeaways:
BOE's hold at 3.75% masks a deepening divide within the Monetary Policy Committee as two members push for a hike to 4%.
The Bank of England is expected to hold its key rate at 3.75% on Thursday, parting ways with the European Central Bank as a weakened jobs market offsets inflation risks from the Middle East conflict.
"We think those advocating for a hold will signal that they remain open to tightening policy later this year," said Edward Allenby, an economist at Oxford Economics.
The decision comes as the ECB raised its key rate for the first time in more than three years, citing a pickup in inflation as energy prices stay elevated. The Bank of Japan also raised rates to a 31-year high, while the Federal Reserve is expected to hold steady at its June meeting under new Chair Kevin Warsh, with fed funds futures pricing virtually no chance of a cut. The UK economy contracted in April after a strong start to the year, giving BOE policymakers cover to wait. A survey conducted by the central bank in April found most businesses expect profit margins to shrink, suggesting limited pricing power.
The outlook hinges on the Middle East. Iran and the US on Sunday agreed on an interim peace deal, but the timeline for reopening the Strait of Hormuz remains unclear. If the conflict is resolved soon, a rate rise this year becomes less likely. If the strait stays largely closed, an increase in borrowing costs is probable. The BOE's next scheduled meeting is in August.
Chief Economist Huw Pill is expected to vote for a quarter-point increase to 4%, with external member Megan Greene likely to join him. Other dissents are possible, though a majority of the nine-member Monetary Policy Committee sees only a moderate risk that higher energy prices will trigger a wage-price spiral. The jobs market has weakened significantly in recent months, making workers more cautious about demanding pay increases, while consumer demand remains subdued.
The BOE had been expecting to lower rates by half a percentage point this year before the Iran war began. Instead, a sharp rise in government bond yields has tightened financial conditions, effectively doing some of the central bank's work for it. Several policymakers have argued in recent speeches that removing the prospect of cuts has itself restrained activity, reducing the need for actual rate increases.
Rate Differentials Widen
The policy divergence between the BOE and ECB is already showing up in currency markets. The euro has strengthened against the pound as traders price in a higher terminal rate for the eurozone. The ECB's move Thursday marked its first rate increase in over three years, while the BOE's key rate at 3.75% remains at a level policymakers previously judged as restraining activity. By contrast, the ECB's key rate was at a neutral level that neither restrained nor encouraged growth.
For UK households, the prospect of borrowing costs staying higher for longer adds to financial strain at a time when energy costs are already elevated. The BOE's next move — whether a hold, a hike, or eventually a cut — will depend on data over the coming months, particularly wage growth and the trajectory of energy prices as the Middle East situation evolves.
This article is for informational purposes only and does not constitute investment advice.
