Middle East Tensions Force UK Central Bank to Halt "Rate Cut Train," Thursday Decision Full of Suspense!

Gold Ten Data

This week’s expected interest rate cut, once considered a certainty by the market, has now completely reversed amid the smoke of Middle Eastern conflict. Faced with a sluggish economy and external energy shocks, will the Bank of England repeat the 2022 “slow response,” or will it take decisive and flexible action?

The Bank of England will likely abandon its previously almost certain interest rate cut plan, as officials need to pause and carefully assess the intense turmoil caused by the Middle Eastern conflict.

Investors and economists generally expect that the Bank of England’s rate decision, to be announced at 8 p.m. Beijing time on Thursday, will show that the Monetary Policy Committee (MPC) will keep the benchmark rate at 3.75%. Previously, U.S.-Israeli strikes on Iran severely threatened efforts to bring inflation back to the 2% target.

Currently, the market believes the next move by the Bank of England is very likely to be a rate hike, a 180-degree reversal from pre-war expectations when traders had priced in about an 80% chance of a rate cut this week.

Although recent meetings have ended with votes split evenly among committee members, this time, economists expect a strong consensus among officials to hold rates steady.

Earlier economic data showed that the UK labor market is weak, economic growth is sluggish, and inflation expectations are cooling—at least before the outbreak of war. All these factors support the case for further easing. However, recent sharp volatility in energy markets is likely to make the Bank of England very cautious, especially considering that after the Russia-Ukraine conflict erupted in 2022, the central bank was heavily criticized for failing to curb soaring prices in time.

Voting Divisions

While Bank of England Governor Bailey cast decisive votes in the past three meetings, most respondents in a Bloomberg survey expect this meeting to support maintaining current policy by a decisive 7-2 margin.

Unlike the lessons from 2022, some economists believe the current macroeconomic backdrop resembles 2011, when rising energy costs pushed inflation above 5%, but policymakers chose to ignore it. As 16 years ago, the Bank of England is now facing a relatively weak labor market, which may help contain a second round of inflation from renewed oil and gas price surges.

Long-standing dovish members Dhingra and Taylor are seen as the most likely to continue supporting rate cuts. However, some economists also expect that the tense voting split may persist after Deputy Governor Brunner and Ramsden supported looser policies in February.

Bank of England Monetary Policy Committee Hawk-Dove Map

Forward Guidance

The MPC may completely overturn its February forward guidance, which previously led markets to expect more rate cuts.

In a calmer economic environment last month, the Bank of England told investors that the benchmark rate “may be further lowered,” but emphasized that the scale and timing of any action would depend on inflation trends.

Given the high uncertainty about how long the current energy price pressures will last, the committee might choose more balanced language to leave room for future decisions.

Barclays Chief UK Economist Jack Meaning said, “We still expect the phrase ‘based on current evidence, the benchmark rate may be further lowered’ to be removed from the statement, and MPC members will emphasize that inflation outlook remains the key factor in determining monetary policy.”

Just three weeks ago, traders were betting that the Bank of England would cut rates twice more by 2026 (including this Thursday), as borrowing costs approached “neutral” levels.

Now, the market believes hopes for action this week are completely dashed, with nearly 25 basis points of tightening priced in before the end of the year, indicating investors now see a higher likelihood of rate hikes than cuts.

This sharply contrasts with economists’ views: most still expect further easing in the future, although they anticipate the timing of rate cuts may be slightly delayed.

Bloomberg Economics UK Chief Economist Dan Hanson said, “If the situation cools quickly, the Bank of England could still cut rates twice this year—this was our baseline forecast before the war broke out, and it’s likely to start from this summer.”

Inflation and Economic Growth Outlook

However, Bank of England officials may signal a change in their optimistic outlook on inflation and the economy outlined in their February forecast.

A full new forecast will not be released until April, but the Bank may warn that rising fuel costs, passed on to households, could push inflation higher than expected in the coming months.

Hanson estimates that soaring fuel costs for drivers will likely raise the March UK inflation rate by about 0.3 percentage points. When the energy price cap, which limits household gas and electricity bills, is raised in July, household financial pressures could intensify further.

Even before any real impact from the Iran conflict, the UK’s economic growth outlook has already been less optimistic than expected. Stagnant GDP in January increases the risk that economic growth will fail to reach the Bank of England’s Q1 forecast of 0.3% output growth.