Interest rates held as Bank of England says inflation set to rise

The UK economy is expected to grow by more than previously forecast this year, according to the Bank of England, although major uncertainties remain because of the Iran war.

The Bank said it expects the pace of price rises – as measured by inflation – to pick up due to volatile oil and gas prices caused by conflict in the Middle East.

But the peak will be slightly lower than previously thought and the UK economy will expand a little more.

The Bank voted to hold interest rates at 3.75% for a fifth meeting in a row. It said any change in borrowing costs would depend on how long the energy shock will last and how severe it is.

The Bank moved marginally towards a rise in rates later in the year with three members of its nine-member rate setting committee voting for a hike, one more than the previous meeting.

If the Iran war continues and oil prices hover around $100 a barrel, then a rate rise seems likely. However, many in the markets expect tensions to subside in the coming weeks, ahead of crucial elections across the US in the Autumn.

Oil and gas prices have seen wild swings in recent days because of uncertainty over the status of the conflict.

On Monday, the price of crude fell as US President Donald Trump said there were "very friendly negotiations" happening between Washington and Tehran.

On Wednesday, oil shot up to more than $91 per barrel as Trump said of Iran: "We'll be hitting them hard. They're going to get a beating."

Recent data showed that UK inflation eased to 2.6% in the year to June, when diesel and petrol prices fell during a brief lull in hostilities between the US and Iran.

Bank of England governor Andrew Bailey said: "Inflation has fallen faster than expected but the conflict in the Middle East continues to mean high and volatile energy prices. That will cause inflation to rise again this year.

"However, as the conflict unfolds, our job is to make sure any increase in inflation is temporary and that it comes back to our 2% target."

The Bank of England examined a range of scenarios of what might happen to inflation and the economy depending on the Middle East conflict.

Inflation was previously expected to reach 3.5% this year.

In a worst-case scenario, where oil prices reach $100 a barrel, the Bank now projects that inflation could reach 3.2% in 2026.

In a scenario where oil prices are around $76 before falling back to $71, inflation could reach 3%.

While better than previously forecast, that remains above the Bank of England's 2% target.

The UK economy is expected to grow by 1.1% this year, ahead of forecasts the Bank made in April.

The Bank of England is ready to raise rates, if the war in the Gulf continues to re-escalate leading to higher oil costs and, in particular, elevated gas prices as Europe refills its storage capacity ahead of winter.

But the judgement on that changes day to day, depending on the responses of the US and Iran. If, as seemed to be the case just a month ago, a ceasefire returns and holds, then energy prices could fall rapidly and raise the prospect of a rate cut.

While the Bank's rate-setting committee voted to hold borrowing costs, three of its nine members wanted to increase the rate to 4%.

Megan Greene, one of the three who voted for a rise, said that while there was uncertainty because of the Iran war, other "risks loom" over inflation.

These include a second choke point for global energy supplies in the Red Sea – Houti rebels in Yemen recently attacked oil tankers passing through the region.

There are also new factors that the Bank is considering. Droughts around the world and the prospect of a "super El Niño" weather pattern could hike food prices.

The price of technology could also be affected by the current convulsions in the market for microchips.