BoE remains in ‘wait and see’ mode

For now, the door to interest rate cuts is closed, and the one to rises remains ajar – by Rob Morgan, Chief Investment Analyst at Charles Stanley Direct, part of Raymond James Wealth Management

The Middle East peace deal could see a welcome tamping of the inflation hump hitting UK households this year, meaning policymakers at the Bank of England can breathe a tentative sigh of relief.

It’s increasingly likely that the bar to raising UK interest rates this year isn’t scaled. In the context of a lacklustre economy and weak demand, rates are already restrictive and borrowing costs have already escalated as rate cuts have been removed from the table – conditions that are doing some of the BoE’s inflation-controlling work for it.

Raising rates at this juncture could cause economic harm and have little impact anyway on higher costs emanating from an energy price spike. All but the most hawkish members of the rate-setting committee are inclined to sit on their hands for a while longer to see how things pan out – and keep one eye firmly on the stagnant economic picture.

At the same time, the door to interest rate cuts remains firmly shut as the inflationary wave from the Iran war passes through. Having fallen back, energy prices may now remain somewhat elevated compared to pre-crisis levels as depleted emergency reserves are rebuilt and production recovers. Combined with the delayed reaction on other major components of the inflation basket such as energy bills and food, it means price rises are set to stay high over the course of the year before falling back.

After the shocks of Covid and the Ukraine war, central bankers remain sensitive to anything that risks embedding another round of inflation. With households bracing themselves for pricier shopping baskets and energy bills in the coming months, worries of second-round effects from higher pay demands are not extinguished.

Yet the opening of the Strait of Hormuz is undoubtedly good news for consumers, business owners, and central banks alike. It means that the price jolt won’t be as ferocious as it might have been, and it could give way to a calmer inflationary setting next year. Overall, it looks like a holding pattern for rates before the bank can look to complete what’s left of its rate cutting cycle in 2027 as the sluggish growth environment continues to take its toll on demand.