Bank of England Review – Policy Outlook Highly Dependent on Situation in Middle East

• The BoE kept Bank rate unchanged at 3.75%, as widely expected.
• On the one hand, 3 MPC members now call for a hike. On the other, the BoE now recognises that the risk to inflation is less imminent and has lowered its inflation outlook.
• We continue to see the BoE remaining on hold this year and have added a rate cut in 2027Q2 to our base case. This hinges on calmer energy markets, though, and the risk is skewed towards a hike in 2026H2.

The Bank of England (BoE) kept Bank Rate unchanged at 3.75% as expected. The decision was taken with a 6-3 vote (against 7-2 in June), with Mann joining the hawkish camp. Not a big surprise given some of her recent remarks. The BoE presented three scenarios in their monetary policy report. The central projection with energy prices conditioned on futures curves and moderate, persistent second-round effects now sees CPI inflation at 2.6% one year ahead, which is lower than all three scenarios presented in April.

The lack of evidence of second-round effects on inflation was also highlighted at the press conference. GDP growth is stronger and the unemployment rate is lower, leading the BoE to conclude that the UK economy is in a better position than anticipated in April. The central projection also incorporates two hikes in line with market pricing.

At the press conference, Governor Bailey highlighted the lack of evidence of second-round effects on inflation, but he also indicated that it might be necessary to act before any such effects appear. What seems increasingly clear is, that future policy will depend heavily on developments in the Middle East. While the vote split indicates a clear upside risk to rates at the short end, things could also turn around in H2. Deputy Governor Ramsden, who is seen as a centrist, now explicitly mentions resuming the cutting cycle if risks subside and the underlying disinflation process continues. In the end, Bailey will likely be the decisive vote, though. He does not look ready to vote for a cut anytime soon.

BoE call. Assuming that energy prices remain below alarming levels, our main scenario remains that the Bank Rate will be unchanged for the remainder of the year. We expect the BoE to resume the cutting cycle and deliver another 25bps rate cut in 2027Q2. For the remainder of the year, risks are tilted to the upside, though. Elevated energy prices over a prolonged period could still trigger a rate hike in H2, even in the absence of spillover to broader price-setting. The economy has been quite resilient despite tighter financial conditions and the cost of an “insurance hike” has declined over recent months.