The Bank of England has maintained its benchmark interest rate at 3.75% but signaled that further increases are likely if the conflict in the Middle East continues to drive inflation higher. The central bank’s Monetary Policy Committee (MPC) voted six to three to keep rates on hold at its latest meeting, citing signs of economic resilience so far, but warned that ongoing geopolitical tensions could prompt policymakers to raise borrowing costs as early as November.

Governor Andrew Bailey highlighted the impact of rising energy prices linked to the war in the Middle East, particularly the heightened volatility in global oil and gas supplies, which has contributed to inflationary pressures in the UK. Inflation rose to 3.1% in August and is forecast to climb to around 4% early next year, significantly above the Bank’s 2% target. Bailey warned that the longer the conflict endures, the greater the likelihood of further rate hikes to contain inflation.

Financial markets currently anticipate a quarter-point rate increase at the November MPC meeting, followed by up to three additional rises by mid-2025, potentially pushing the Bank rate to 4.75%. This outlook aligns with recent actions taken by other major central banks, including the US Federal Reserve and the European Central Bank, which also have raised rates in response to energy cost pressures.

Households and businesses are already feeling the strain as mortgage lenders have increased fixed-rate deals, with the average five-year fixed mortgage rate now at approximately 5.87%, marking its highest point since late 2023. Energy costs are expected to rise sharply, with Bailey informing Chancellor John Healey that average energy bills could surge by 24% in January, reaching more than £2,100 annually.

Amid this economic uncertainty, the Bank also announced a new approach to its quantitative tightening (QT) programme. The Bank plans to sell £146 billion of UK government bonds back to the Treasury to reduce volatility in the gilt market, a move requiring Treasury approval and introducing new complexities into government financing ahead of the October 28 budget. The Debt Management Office will issue shorter-term debt to cover the Treasury’s financing needs, aiming to minimise market disruption while completing the drawn-out process of unwinding crisis-era asset purchases.

Chancellor John Healey faces mounting pressure as he prepares for his first budget under these challenging conditions. With inflation and energy prices rising, alongside anticipated increases in borrowing costs, Healey has indicated readiness to make difficult decisions on taxes or spending cuts to manage the public finances. He has met with union leaders and signaled a commitment to providing some relief to businesses and workers where possible.

While the UK economy shows some resilience and inflationary second-round effects—where rising prices prompt higher wages and costs—have not yet taken hold significantly, risks remain elevated. Potential food price increases linked to recent droughts and disruptions in Ukraine add to the uncertainty. As the Middle East conflict appears set to continue without clear resolution, policymakers face a delicate balance between supporting growth and containing inflationary pressures in the coming months.