Interest rate increase ‘likely’, warns Bank of England

Andrew Bailey has said that interest rates are likely to rise if the Middle East war rages on, warning inflation is now on course to hit 4pc. The Bank of England opted to hold borrowing costs at 3.75pc on Thursday, the sixth time in a row it has left them unchanged. However, the Governor said a “material” increase in energy prices since July would push up inflation to twice the Bank’s 2pc target. He warned that the outlook for inflation “continues to be on the upside” and criticised the “seeming loss of urgency to find solutions” to the war in Iran. Oil prices are back above $100 a barrel and analysts expect average gas and electricity bills to rise above £2,000 this winter as the conflict continues. Mr Bailey said: “So far, higher global energy costs have had a limited effect on price and wage setting in the UK. “But the longer this volatility persists, the bigger the impact it will have on inflation, and the more likely it is we will need to raise Bank Rate to ensure that inflation falls back to our 2pc target.” Investors expect the Bank to raise interest rates as soon as November, which has pushed average mortgage rates to their highest level in three years. The average five-year fixed mortgage deal has risen to 5.87pc, according to Moneyfacts, which is the highest level since November 2023 and up from 4.95pc before the Iran war. Thursday’s rate hold leaves the Bank out of step with central banks around the world after the US Federal Reserve and European Central Bank voted to raise borrowing costs this month. However, many economists said there had been a significant change in tone from policymakers over the threat posed by energy prices and whether this would feed into the wider economy. The Bank of England predicted that inflation would hit 4pc early next year, just as most workers are negotiating pay rises. Paul Dales, chief UK economist at Capital Economics, said: “It seems as though a majority of the MPC is on the cusp of wanting to tighten policy just in case the burst of imported energy inflation transforms into a longer lasting rise in domestic inflation.” In a warning on the impending pain facing households, Mr Bailey told the Chancellor that energy bills would rise by 24pc early next year under the Ofgem price cap. This would push up annual average bills by £413 to £2,136, which the Governor blamed on the war in the Middle East. The Governor is required to write a formal letter to the Chancellor every time inflation is more than a percentage point above its 2pc target. Official data showed inflation rose to 3.1pc in August. Mr Bailey said: “The energy price shock has been the most important factor driving recent short-term movements in inflation.” Despite expectations of higher rates, the FTSE 100 rose on Thursday at its steepest pace since July, climbing more than 1pc, as the Bank of England eased the pressure on the UK bond market. Policymakers also confirmed a Telegraph report that the Bank will stop selling the long-dated bonds it amassed during the financial crisis and lockdown. The Bank will continue actively selling £20bn of government bonds per year until the rest of the stockpile is wound down to zero in 2034. The announcement triggered a sharp fall in the cost of borrowing for the Treasury, with the yield on 30-year UK gilts falling at the fastest pace since May. Read the latest updates below.