The Bank of England controls rates and explains the risk of inflation from the Iran war

*Bank of England MPC votes 8-1 to hold interest rates at 3.75%

* BoE Chief Economist Huw Pill votes for 4% rate hike

* BoE sets new inflation targets triggered by Iran war

* Inflation could exceed 6% in early 2027 if oil prices remain high

LONDON, April 30 (Reuters) – The Bank of England kept interest rates on hold on Thursday and set conditions on the economic impact of the Iran war, one of which could require a “significant” increase in borrowing costs.

The nine members of the Monetary Policy Committee voted 8-1 to keep the BoE’s Bank Rate at 3.75% and only Chief Economist Huw Pill wants it to rise to 4.0% now, in line with expectations in a Reuters poll of economists. A day after the US Federal Reserve held interest rates on hold and shortly before the European Central Bank is expected to remain on hold, the MPC said it will continue to closely monitor the situation in the Middle East. Investors reacted cautiously to the BoE announcement with little positive change against the US dollar and the euro. However, the two-year British government bond yield, which is sensitive to speculation about BoE rates, fell by 5 basis points.

Scott Gardner, chief investment strategist at JP Morgan Personal Investing, said the MPC had given itself more time to assess the potentially volatile nature of the war.

“Policymakers will be wary of being caught off guard or overreacting and testing what could be short-term price shocks,” Gardner said. “Timing to buy is a decision at this point as uncertainty remains high.”

The MPC said that while there is a risk of a “second material cycle effect” due to energy price shocks – such as higher wage demands or companies raising prices rather than containing higher costs – the labor market is slowing and rising borrowing costs in financial markets will limit inflation.

“The Committee stands ready to act as necessary to ensure that CPI inflation remains on track to meet the 2% target over the medium term,” it said in a statement, repeating the language it used after its last meeting in March.

Investors view Britain as vulnerable to rising electricity prices due to the country’s heavy use of natural gas.

Data published last week showed a rise in input costs for firms and companies raising their expectations for price increases over the next 12 months at a record pace.

But there are also concerns about a major shock to economic growth caused by the war.

SCENES OF LIFE

Faced with deep uncertainty about the duration of the war and the extent of the economic damage it will cause, the BoE abandoned its usual practice of publishing an average forecast of inflation and other key economic indicators.

Instead, it produced three scenarios based on power values ​​and different levels of second round results. Under the more damaging Scenario C, where energy prices remain high for longer, inflation could reach 6.2% in early 2027 – almost double its latest reading – and remain above the BoE’s 2% target over the next three years, based on current market expectations for rates.

If that risk materializes, “a tightening of monetary policy is likely to be warranted,” the BoE said.

However, Scenarios A and B would require a “less restrictive policy environment” with market-based interest rates rising since the start of the war to help offset inflationary pressures. The conditions were based on market prices in the 15 days to April 22 and did not include another increase in world oil prices this week that rose four years ago on Thursday due to renewed concerns about the length of the war. BoE Governor Andrew Bailey said he placed more weight on Scenario B “despite the slightly reduced second-round effects”, but also placed “some weight” on Scenario C.

About half of the other MPC members voted to freeze rates and said they put more weight on Scenario B.

Some MPC members “may choose to act early” to avoid the risk of inflation getting stuck too high while others prefer to wait for more evidence of such an increase in risk, the BoE said.

Earlier this month, Bailey told investors in an interview with Reuters that their bets on interest rate hikes this year were premature due to uncertainty about the duration and impact of the war.

Before the BoE’s announcement on Thursday, investors were pricing in about a quarter-point rate hike this year.

As well as its heavy exposure to higher fuel prices, Britain’s economy is facing political concerns as Prime Minister Keir Starmer struggles to hold onto the reins of Downing Street, which has raised questions about the government’s financial plans.

British government bond yields are the highest among the Group of Seven economies. (Written by William Schomberg)

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