Bank of England Holds Interest Rate, Warns Middle East Conflict Is Heightening Inflation Risks

The Bank of England (BoE) kept interest rates unchanged at 3.75 percent on Sept. 17 but signaled it could tighten policy if persistently higher energy prices driven by the Middle East conflict fuel broader inflation pressures.

Global energy prices have risen sharply since July, driven by events in the Middle East and the war in Ukraine, according to the BoE’s assessment.

The front-month Brent crude futures contract settled at $84 a barrel, while the UK front-month natural gas futures contract closed at 136 pence ($1.82) per therm on July 28. By mid-September, Brent crude had risen above $100 a barrel.

BoE Governor Andrew Bailey said the sharp increase in energy prices had materially worsened the near-term inflation outlook.

“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 2 percent target,” he said.

He warned that persistently higher energy and food prices could eventually lead to stronger second-round inflationary effects.

BoE’s decision came a day after the U.S. Federal Reserve delivered its first interest rate increase in more than three years, raising its benchmark federal funds rate by a quarter of a percentage point to a target range of 3.75 to 4 percent.

UK Inflation

Bailey’s remarks came as UK inflation rose by 3.1 percent in the 12 months to August 2026, up from 2.9 percent in July.

Responding to the increase, British Chancellor John Healey said in a Sept. 16 post on X that it reflected a global energy shock rather than domestic factors.

“The war in the Middle East is impacting on inflation worldwide. Not just here at home,” Healey said.

He said government measures, including cutting taxes on electricity bills, capping bus fares, and reducing business rates for pubs, clubs, and music venues, were helping ease pressure on households and businesses.

So far, higher energy costs have had only limited indirect effects on domestic prices and wages.

Food inflation, for example, has remained weaker than expected, with the BoE’s regional agents now expecting annual food inflation to be around 4 percent by the end of 2026, compared with earlier expectations of 6 to 7 percent.

However, the BoE said those effects may have been delayed rather than avoided and warned that drought conditions in Europe, El Niño, and continued energy market pressures could push food prices higher in 2027.

Reflecting the stronger energy price outlook, the BoE expects inflation to rise to around 3.75 percent in the final quarter of 2026 before climbing to slightly above 4 percent in the first quarter of 2027.

Economic Resilience

The MPC said the UK economy has performed slightly better than expected despite headwinds from global conflicts and higher interest rates.

The BoE said GDP had been slightly stronger than expected. Official data showed monthly GDP rose 0.4 percent in July, driven by business-to-business services.

Business optimism, consumer confidence, and the S&P Global UK composite output PMI improved in August, the BoE said. The labor market, however, remained soft, the policymakers added.

The unemployment rate was estimated at 4.9 percent in the three months to July, unchanged from the previous reading. The BoE said, however, that there were tentative signs that labor market slack had begun to stabilize as some hiring indicators improved.

Underlying private-sector wage growth was estimated at around 3.5 percent, and most businesses expected wages to rise at a similar pace next year despite higher inflation.

Reuters contributed to this report.