The Bank of England has entered a new phase of inflation management following the outbreak of the Iran war, holding rates at 3.75% on Thursday and warning that the conflict’s energy price impact has created a more challenging and uncertain environment than the UK has faced for some time. The monetary policy committee voted unanimously to hold, describing the war as a significant new shock that had replaced the relatively predictable challenge of managing a gradual return to target with the much more complex task of responding to an unpredictable geopolitical disruption. Officials said inflation could rise above 3% and that borrowing costs might need to increase.
The new phase of inflation management is characterised by several features that distinguish it from the recent period of gradual disinflation. The primary driver of inflation is now external rather than domestic, limiting the effectiveness of domestic monetary tools. The duration and severity of the shock are inherently unpredictable, making forward guidance more difficult. And the domestic economic context — weakening labour market, slow growth — creates competing pressures that complicate the policy response.
Governor Andrew Bailey described the Bank’s approach to the new phase as one of careful observation and conditional readiness. He said the Bank was watching the energy price situation closely and was prepared to act through rate policy if the inflationary consequences became entrenched. His emphasis on conditionality was designed to preserve flexibility while maintaining credibility on the inflation target.
Financial markets interpreted the new phase as inherently hawkish. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders priced in rate hikes before year end. Analysts noted that the transition to a new phase of inflation management would require both the Bank and the public to adjust their expectations and planning assumptions.
For UK institutions, businesses, and households, the new phase of inflation management demands a similar adjustment. Plans made for the old phase — gradual rate cuts, declining inflation, improving real wages — need to be revisited in light of the changed environment. The Bank’s transparent communication about the new challenges is an important starting point for that adjustment, even if the specific policy response remains uncertain.