Bank of England keeps interest rates at 3.75% as Iran conflict weighs on economy

The England" class="entity-link entity-organization" data-entity-id="2477" data-entity-type="organization">Bank of England has left interest rates on hold, arguing that reacting too quickly to inflation threats risked creating “undesirable volatility”, as the Iran-war" class="entity-link entity-event" data-entity-id="38748" data-entity-type="event">Iran war weighs on the UK economy.Seven of the nine-person monetary policy committee voted to keep rates at 3.75% as the MPC weighed the threat of higher inflation against the prospect of an economic slowdown.Two members, however, voted for an immediate rise, indicating the risk that borrowing costs could soon increase.Donald Trump’s pact with Iran, expected to be signed on Friday, has brought oil prices down rapidly in recent days and figures released on Wednesday showed UK inflation was more muted than feared, at 2.8%, last month.The Bank now expects the impact of the conflict on UK inflation to be less dramatic than first feared, with the consumer prices index rising to about 3.25% in the fourth quarter of this year – lower than any of three scenarios it laid out last month.That is still well above the Bank’s target of 2%. But the Bank’s governor, Andrew Bailey, explaining his vote, said that rapid reaction to rising inflation carried a risk of “undesirable volatility”, and suggested that the current weakness of the economy – including the jobs market – should help to contain the risk of inflation becoming entrenched.“Given the context at present of softness in the real economy and uncertainty around the scale and duration of the shock to energy prices, tolerating temporarily above-target inflation as part of a return to target is an appropriate way to approach the trade-off, providing inflation expectations remain contained,” he said.Bailey added: “oil prices have fallen in recent days, and that’s encouraging. But they’re still higher than before the war. Whatever happens in the future, the higher energy prices of the past four months mean there’s already some inflationary pressure in the pipeline.” He said the Bank would attempt to ensure that inflation did not stay above its 2% target for a “sustained” period.However, the minutes of the meeting, published alongside the decision, reveal that the MPC remains concerned about the risk that higher energy prices feed through into wider inflation in the coming months.Huw Pill warned of the risk of ‘catch-up dynamics’. Photograph: Suzanne Plunkett/Reuters“The committee will continue to monitor closely the situation in the Middle East and how its impact propagates through the economy. The committee stands ready to act as necessary to ensure that CPI [consumer price index] inflation remains on track to meet the 2% target in the medium term,” the minutes say.Megan Greene, an independent member of the MPC, joined the Bank’s chief economist, Huw Pill, in voting for a quarter-point rise, to 4%, however. The hawkish Pill had already backed a rise at the Bank’s last meeting in May.Explaining his decision, Pill said: “Global energy prices remain volatile, and elevated compared with their pre-hostilities level, despite the announcement of a new ceasefire” – and he warned of the risk of “catch-up dynamics”, as companies and workers bid up prices and wages in response to higher costs, embedding inflation in the economy. “I continue to favour prompt but modest action on bank rate now,” he added.The Bank’s wait-and-see stance contrasts with that of the European Central Bank (ECB) which raised rates last week in an attempt to squeeze inflation.The MPC minutes highlight the fact that borrowing costs forconsumers and businesses have already risen significantly since the Iran conflict began, as a result of shifts in bond markets – despite the Bank not having taken any action. The minutes highlight the fact that there has been “full and fast pass-through” of these market moves, to mortgages and business loans.Figures released by the Office for National Statistics on Thursday showed that the number of UK job vacancies fell to its lowest level for five years as businesses cut back on recruitment, despite signs that the labour market has been more resilient to the Iran-war" class="entity-link entity-event" data-entity-id="38748" data-entity-type="event">Iran war than feared.UK markets will be closely watching the outcome of Thursday’s byelection in Makerfield, with the prospect of a period of political uncertainty unlikely to be welcomed by investors in the UK’s bonds.On Wednesday, the Federal Reserve kept US interest rates on hold at a range of 3.5% to 3.75%, where they have been since December, in the first meeting overseen by Kevin Warsh, who took over as Fed chair in May.