BoE recap: Divided rate rise accompanied by warning that energy shock is not over

Sharply higher inflation forecasts accompanied the Bank of England’s (BoE) decision to raise Bank Rate by 25 basis points to 4.00%, as it warned that energy pressures could necessitate further tightening. Eight policymakers supported the increase, while Catherine Mann favoured a larger 50-basis-point rise.

Inflation is now expected by the “Old Lady” to peak at around 5% in Q2 2027, compared with its previous forecast of 3.2% in late 2026. A return of CPI inflation to the 2% target is unlikely before Q3 2028. Under the Bank’s adverse scenario, a worsening energy shock would push inflation to 6.2%.

Inflationary pressure already in the pipeline was sufficient to justify the increase, according to Governor Andrew Bailey. He warned that further rate rises remained possible and that the Middle East crisis might not yet be over. Nevertheless, he stressed that the decision did not mark the beginning of an inevitable succession of increases. Although the Bank continues to find little evidence of second-round effects, economic activity exceeding expectations has strengthened the case for tighter policy.

An improved near-term growth outlook sits alongside a mixed broader economic picture. Having raised its short-term forecasts, the BoE now projects GDP growth of 1.6% in 2026, followed by a slowdown to 1.3% in 2027 and 1.2% in 2028. Unemployment is expected to edge higher, while pay growth is now forecast to exceed earlier estimates. The government’s budget is expected to curb inflation temporarily, though that effect is likely to reverse later.

Despite its broadly hawkish tone, the Bank stopped short of committing to further tightening. A further increase in the near term has a case in its favour, according to MPC members Lombardelli and Pill, while Greene indicated that additional rises would probably be necessary. Bailey, however, described the existing policy stance as broadly sufficiently restrictive. He also attributed part of the rise in market interest rate expectations to risk premia rather than the Bank’s anticipated policy path. By raising rates, the MPC has sought to protect against a worse inflation outcome while deliberately leaving its next decision open.