Bank of England hikes rates to 4% as Iran war fuels inflation, eyeing Trump's next Middle East move

The Bank of England has increased interest rates to 4 percent from 3.75 percent. Its nine-member Monetary Policy Committee announced on Thursday that it had overwhelmingly voted for the increase, the first since August 2023, to combat rising prices driven by the war in Iran.

The committee voted 8 to 1 on Wednesday to raise rates, arguing that the energy shock since the war began has built sufficient inflation pressures to justify a hike. The dissenting vote, from Catherine Mann, was for a larger increase of 0.5 percentage points.

UK inflation came in at 3.5 percent in September, while the economy posted better-than-expected growth figures, raising the risk that prices could take off. The Bank said it was forced to act in those conditions. Until now, Governor Andrew Bailey and other committee members had preferred to wait and see whether higher energy prices spilled over more broadly.

Governor Andrew Bailey said Thursday's increase is unlikely to be the last unless the conflict in the Middle East is resolved. At the same time, he said today's increase should not be seen as the first in an inevitable long sequence of hikes.

The Bank projected inflation would pick up to nearly 5 percent by the second quarter of 2027, higher than its previous forecast, with greater spillover into wages and other prices. Under an adverse scenario, in which prices stay higher for longer and the conflict in the Middle East continues to flare, inflation would hit 6.2 percent in the third quarter of 2027.

Thursday's decision comes a week after Chancellor John Healey delivered his first budget under the spectre of Britons paying the highest energy prices in three years. It will further squeeze households and businesses already hit with higher energy bills and mortgage rates.

Still, the Bank's top officials also pushed back on market expectations that rates could be hiked to 4.75 percent or 5 percent in 2027.

The rout of Trump's Republican Party at the US midterm elections on Tuesday raised the prospect of a peace deal in the Middle East. A thaw in the conflict could bring down fuel prices by easing pressure on oil supplies and improve the cost-of-living picture for UK households.

There were reports Trump could respond to his party's losses by embarking on a bombing campaign in the Middle East, but the US president appeared on Wednesday to accept that higher petrol prices affected his popularity and struck a more conciliatory tone on the prospect of peace negotiations. US Vice-President JD Vance blamed the Iran war for the electoral losses, and UK Prime Minister Andy Burnham said on Wednesday that the elections create an opportunity to focus on the cost of living. Oil prices fell sharply on Wednesday.

Regardless, UK consumers will feel the pinch through a rise in the energy price cap in January. The Bank forecast the cap will hit 2,150 pounds in the first quarter of 2027. Food price increases, which have so far been muted, could hit 4.75 percent by mid-2027. The Bank said Healey's budget will knock 0.25 percentage points off inflation by the second quarter of next year, while tighter fiscal policy to bring down the deficit would likely detract from growth in the medium term.