UPDATE: BoE raises rates as Bailey signals possible second hike

Bank of England Governor Andrew Bailey on Thursday signalled that a second interest rate increase could be necessary unless progress is made towards resolving the conflict in the Middle East, but stressed that a prolonged cycle of monetary tightening was not inevitable.

The comments came after the BoE's monetary policy committee voted by 8-1 to raise the bank rate by 25 basis points to 4.00% from 3.75%, as rising energy prices threatened to push UK inflation to around 5.0% by the middle of next year.

Speaking at a press conference following the decision, Bailey warned that the longer the conflict persisted, the greater the risk of inflationary pressures becoming embedded in the economy, potentially requiring further interest rate increases.

"These increases should not be seen as the first of an inevitable long sequence of hikes. That is not inevitable. But unless the conflict in the Middle East is resolved, neither does it seem likely to be the last increase," Bailey said.

Asked specifically about the possibility of a second increase, Bailey said: "In the absence of a resolution of the conflict, I think that the case for a further 25 [basis points], without any commitment on when it would come, would be quite strong."

However, he stressed that recent developments in energy markets could materially alter the outlook for inflation and monetary policy.

Wholesale Brent crude oil and UK natural gas prices have fallen by around 15% since the start of the week, to approximately USD95 a barrel and 180 pence per therm, respectively, amid hopes of progress towards resolving the conflict.

Bailey described the declines as encouraging, although he cautioned that considerable inflationary pressures were already in the pipeline.

He said the recent fall in energy prices would not have changed Thursday's interest rate decision, but could influence whether another increase was necessary.

"If we continue to get good news on the conflict, that will reduce the risk of further inflationary pressures building," Bailey said.

The governor added that a sustained decline in energy prices could bring the expected peak in UK inflation somewhat below 5.0%.

Nevertheless, he warned that uncertainty surrounding the conflict remained considerable, making it difficult to provide assurances about the future path of interest rates.

The BoE's latest projections show consumer price inflation rising to 3.5% in September, reaching around 4.5% in the first quarter of 2027 before peaking at 4.9% in the second quarter.

The central bank expects inflation subsequently to ease as the direct impact of higher energy prices fades and restrictive monetary policy weighs on domestic price pressures.

However, its central forecast assumes wholesale energy prices decline over the coming years, implying some form of resolution to the conflict and reduced disruption to global energy markets.

Under an adverse scenario in which the conflict persists and energy prices remain elevated, inflation could peak at 6.2% and remain above the BoE's 2.0% target throughout the forecast period.

In that scenario, oil prices are assumed to average around a third higher and natural gas prices around two-thirds higher than in the central projection.

Bailey warned that a prolonged period of elevated energy prices would increase the likelihood of persistent inflationary pressures feeding through into wages and broader consumer prices.

"The longer the conflict persists, and elevates energy prices, as in the adverse scenario, the more likely persistent inflationary effects will take hold, and the higher the level of interest rates will need to be," he said.

However, he emphasised that the adverse scenario represented a risk rather than a commitment to further monetary tightening.

The MPC said monetary policy was not on a pre-set path and that future decisions would depend on developments in energy prices, underlying pay growth, business pricing behaviour and spare capacity in the economy.

The minutes showed that eight members, including Bailey, Deputy Governors Sarah Breeden, Clare Lombardelli and Dave Ramsden, backed the 25-basis-point increase.

Catherine Mann was the sole dissenter, favouring a larger 50-basis-point increase to 4.25%, arguing that a more forceful response was needed to prevent persistent inflationary pressures from becoming embedded in wage and price-setting.

Several committee members also indicated that further tightening could be necessary.

Chief Economist Huw Pill said a single 25-basis-point increase was unlikely to be sufficient to address the risks to price stability, while Lombardelli saw a likely case for another increase in the near term unless inflationary pressures weakened.

Megan Greene also judged that additional increases would probably be required, although subsequent decisions would depend on developments in wages, pricing behaviour and economic slack.

By contrast, Alan Taylor characterised Thursday's decision as a risk-management measure rather than the beginning of a predetermined tightening cycle, saying the next move could be an increase, a decrease or no change.

Bailey also addressed expectations in financial markets, suggesting that some of the upward slope in interest rate futures reflected a premium for uncertainty rather than expectations of further rate increases.

The BoE's latest market participants survey showed a median expectation for the bank rate to reach 4.25% in February, while the market curve was indicating a peak of around 4.75% at the time of the press conference.

Bailey said the difference partly reflected the uncertainty surrounding the conflict and the risk of further energy price volatility.

Meanwhile, the governor highlighted the UK economy's resilience despite higher borrowing costs and rising energy prices.

The BoE said economic activity had generally been stronger than expected in recent months, with evidence that investment linked to artificial intelligence had contributed to growth.

According to Bank staff estimates, AI-related activity accounted for just under a fifth of UK gross domestic product growth since the start of the year.

Bailey also noted tentative signs that the weakening labour market was stabilising, although spare capacity remained and consumer confidence had recently deteriorated.

The MPC said there was still limited evidence of higher energy costs feeding through into broader consumer prices and wages.

However, it warned that businesses' ability to absorb higher costs through reduced profit margins, fixed-price energy contracts and hedging arrangements was likely to prove temporary.

The BoE expects food price inflation, which stood at 1.3% in September, to rise to around 3.0% in the first quarter of next year as higher energy costs feed through supply chains.

Bailey said the central bank remained particularly concerned about inflation's impact on lower-income households and those struggling to find work.

He stressed that monetary policy could not directly influence global energy prices and that resolving the conflict remained the most effective way to reduce inflationary pressures.

Meanwhile, the BoE on Thursday raised its forecasts for UK economic growth in 2026 and 2027.

The central bank now estimates gross domestic product to hit 1.6% this year and 1.3% next year.

In July, it had forecast GDP output of 1.1% for both years.

For 2028, it now expects growth of 1.2%, lower than previously estimated 1.7%.

The MPC will announce its next interest rate decision on December 17.

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