The Bank of England is set to hold rates for now, but rising energy prices and the Fed’s latest hike are reviving bets on a broader global rate-hike cycle
The Bank of England is expected to keep interest rates unchanged on Thursday, but rising energy prices and the US Federal Reserve’s return to rate hikes have put the focus on how long the UK can continue holding borrowing costs steady.
The BoE is widely expected to leave its Bank Rate at 3.75 per cent. But financial markets are increasingly pricing in the possibility of a rate hike later this year as the surge in energy prices threatens to push inflation higher.
That puts the UK in a difficult position. The central bank is dealing with higher inflation at the same time as its labour market and broader economy show signs of losing momentum.
The debate has become more important after the US Federal Reserve raised its benchmark interest rate by 25 basis points on Wednesday to 3.75 per cent -4 per cent. It was the Fed’s first rate hike since July 2023. The US central bank also signalled that another increase could come before the end of the year.
Energy prices put central banks on alert
The common factor behind the shift in rate expectations is energy.
Brent crude and British natural gas prices have risen sharply this month as the war with Iran disrupts energy supplies. Higher fuel and utility costs can feed directly into headline inflation and also raise costs for businesses.
More from BusinessUK inflation rose to 3.1 per cent in August, above the BoE’s 2 per cent target. However, core inflation remained at 2.6 per cent and services inflation was unchanged at 3.4 per cent, giving policymakers some reason to avoid an immediate rate increase.
The problem for the BoE is that an energy shock can create a difficult policy trade-off.
Higher interest rates can suppress demand and prevent a temporary energy shock from becoming embedded in wages and prices. But raising rates when growth and employment are weakening can further weigh on the economy.
The BoE has therefore been cautious about giving markets the impression that a rate-hiking cycle is inevitable.
Governor Andrew Bailey has pushed back against the idea that a rate increase is simply a matter of time. He has said the path will depend on economic and geopolitical developments, while warning that markets may be pricing in too much tightening because of the risk premium created by the energy shock.
Markets see a hike, economists remain divided
Financial markets have moved much more quickly than policymakers.
Investors were pricing in around an 80 per cent probability of a 25-basis-point BoE hike in November, according to the Reuters report. Markets were also pricing several increases over the following year.
Economists have been more cautious. A Reuters poll earlier this month showed most economists expected Bank Rate to remain at 3.75 per cent for the rest of 2026 and into at least the middle of 2027.
Some major banks have since become more hawkish. Goldman Sachs and Citi have both moved towards expecting BoE rate increases later this year as energy prices and inflation risks have risen.
This creates an unusual gap between what markets are pricing and what policymakers have indicated.
Fed hike changes the global picture
The Fed’s decision has added another layer to the debate.
US policymakers raised the federal funds target range to 3.75-4 per cent and signalled another increase before the end of 2026. Sixteen of the 18 policymakers projected at least one more hike this year.
The Fed’s latest projections put US inflation at 3.7 per cent for 2026, well above its 2 per cent target. Policymakers expect inflation to gradually return towards 2 per cent, but the latest projections suggest the process could take several years.
When the world’s largest central bank raises rates, US Treasury yields and the dollar can become more attractive to global investors. Higher US yields can also put pressure on other central banks to consider their own interest-rate settings, particularly if currencies weaken and imported inflation rises.
The Fed’s move therefore comes at a sensitive moment for global monetary policy.
The European Central Bank has also moved towards tighter policy as the energy shock raises inflation concerns, while investors are watching the Bank of Japan for signs of further increases.
The result is a striking change from the global rate-cut narrative that dominated markets earlier.
(With inputs from agencies.)
