LONDON: Bank of England (BoE) governor Andrew Bailey has given an unusually frank message after July’s interest rate decision: “Please do not leave this room thinking that the BoE is edging toward a hike.”
He may struggle to be quite so emphatic at his central bank’s next interest-rate decision on Thursday.
Upside pressures are coming hard and fast from the unresolved Iran war, with the price of Brent crude oil firmly above US$100 a barrel and gas costs proving a particular challenge to the United Kingdom (UK).
New risks are approaching too, threatening to keep inflation above the BoE’s 2% target well into next year.
Bailey told lawmakers earlier this week that energy prices “could be higher still” and that risks are also emerging for food costs, following widespread drought in the UK and the looming effects of a supersized El Nino.
Other parts of the consumer shopping basket look ominous too, such as air fares, while fast growth suggests stronger than expected demand in the economy.
“Energy passes the baton on to food prices in a way,” said Hetal Mehta, chief economist at St James’s Place.
“The broader El Nino effect is likely to keep inflation much stickier next year. Even if the Iran-related energy price disinflation happens, you’ll have a different wave of food price inflation to overlay, which just prevents the overall numbers from coming down materially.”
Markets have shifted accordingly.
In the days after Bailey’s July press conference traders were pricing in less than a full quarter-point rate hike by year-end, yet as of Sept 11 they had 46 basis points of tightening priced in and were betting on as many as four hikes by next summer.
Most BoE officials have argued that a weak labour market and slower anticipated growth in the second half of this year can help contain the price pressures triggered by the Iran war.
While the gross domestic product data for July suggested the economy may be resilient, evidence generally supports the view that second round effects are under control.
There is little sign yet inflation is becoming embedded.
The BoE’s inflation expectations survey for August published last Friday showed a dip to 3.2% over the coming year, from 4% in May.
For the following 12 months, expectations fell to 2.9% from 3.5% in May.
The BoE’s agents survey of businesses across the country found that pay settlements for 2027 will be “broadly in line with or lower than 2026”, when they averaged 3.6%.
However, the BoE may have to change tack at some point.
Oxford Economics estimates that UK inflation – currently at 2.9% – could hit almost 4% by the turn of the year.
That would be double the BoE’s target and above levels at which the central bank believes households start to notice more rapid price increases.
One key driver will be the UK’s energy price cap, which limits how much suppliers can charge consumers per unit.
Regulator Ofgem has announced it will hit a three-year high in October and experts say it could rise further still in early 2027.
“We think the impact of the Middle East conflict is still building,” said Andrew Goodwin, chief UK economist at Oxford Economics.
“We think the price cap could rise by another 13% in January. Wholesale prices are currently well above the level of the previous observation window.”
The food industry is also warning that a combination of higher energy costs, harvests impacted by the scorching UK weather and El Nino will feed grocery bills well into next year. — Bloomberg
