LONDON: The Bank of England predicted British inflation will top 4% early next year as it held interest rates unchanged on Thursday, and Governor Andrew Bailey warned explicitly that prolonged conflict in the Middle East may require tighter policy.
The Monetary Policy Committee again voted 6-3 to keep interest rates at 3.75%, with three members voting for a raise to 4%, in line with economists' median forecast in a Reuters poll.
The minutes from this week's meeting, however, marked a clear shift in tone.
"So far higher global energy costs have had a limited effect on price and wage setting in the UK. But the longer this volatility persists, the bigger the impact it will have on inflation, and the more likely it is we will need to raise Bank Rate to ensure that inflation falls back to our 2% target," Bailey said.
The BoE said inflation risks had tilted further to the upside since publishing its last set of economic forecasts in July, adding that the move in energy prices since then bore similarities to its "adverse" scenario that risked entrenching inflation.
While the BoE noted that signs of persistent pressure were not yet emanating from the labour market and businesses' pricing, it said the risk was growing.
The central bank also rewrote its plan to run down its stock of British government bonds accumulated in past attempts to stimulate the economy, which means it will halt its sales of gilts to the market for the time being.
But most households and businesses will be focussed on the shifting outlook for interest rates.
The warning of rate hikes comes at a difficult time for Prime Minister Andy Burnham and his finance minister John Healey, who are trying to strike a positive tone about Britain's economic outlook ahead of the budget on October 28.
While the BoE bumped up its estimate of quarterly economic growth for the third quarter to 0.4% from its previous 0.1% estimate, it said inflation - at 3.1% in August - could "now reach slightly over 4% in early 2027". Previously, the BoE had forecast a peak of 3.2% in late 2026.
Inflation has surpassed the 2% target for all but three months out of the last five years and the BoE strengthened its language surrounding the outlook for price pressures.
"Given the lags with which second-round effects appeared, it was not appropriate to wait too long for evidence of such effects before responding with policy," the BoE said.
Chief Economist Huw Pill and external MPC members Megan Greene and Catherine Mann again voted to raise interest rates by a quarter point.
But this time Governor Bailey and his deputies Sarah Breeden, Clare Lombardelli and Dave Ramsden all raised the prospect of increasing Bank Rate in future in the policy minutes.
The BoE overhauled its approach to unwinding its stock of gilts, which until now had been set on a year-by-year basis announced each September.
The MPC instead said it wanted to cut the stock of gilts held for monetary policy purposes to zero by 2034, while retaining some very long-dated bonds it had bought to back the issuance of bank notes.
In a break from the past where it would actively sell British governments bonds back to the market across a range of maturities, the BoE said it would hold gilts that mature before 2035 until they mature.
It will also consider selling gilts that mature between 2035 and 2049 back to the government, although it would announce its plans before April next year.
In the meantime, the BoE said it would pause all of its active sales. - Reuters
