Bank of England holds rate at 3.75% as energy shock clouds inflation

The Bank of England left its benchmark interest rate at 3.75% on Thursday, matching expectations in a Reuters poll, as U.K. policymakers weighed above-target inflation against weak economic output. Markets continued to price in a rate increase by year-end, according to LSEG data cited by CNBC, even after Washington and Tehran signed a framework aimed at moving toward a peace settlement.

Seven of the nine members of the Monetary Policy Committee supported keeping the bank’s base rate unchanged, CNBC reported. Chief economist Huw Pill and external committee member Megan Greene voted to raise the rate by 25 basis points to 4%.

The base rate is the Bank of England’s main policy lever for influencing borrowing costs across the economy. A higher rate tends to tighten financial conditions for households and companies, while a lower rate tends to ease them. In this case, the committee chose to wait while it assessed whether energy-driven price pressures would spread more broadly.

The decision came after U.K. consumer price inflation held at 2.8% in May, below expectations, with fuel costs for transport among the drivers of price growth. Separate data released last week showed the U.K. economy contracted 0.1% in April.

Energy prices remain central to the outlook. The Bank of England said in its summary that prices had eased from their initial jump, but the Iran war made their path difficult to predict. The U.K., as a net energy importer, is exposed to global price shocks. The country’s regulated energy price cap is due to rise 13% later this summer, when energy costs are expected to reach a two-year high, according to CNBC.

“The impact on the economy and inflation will depend on how long energy prices stay raised,” the Bank of England said. It added that monetary policy cannot change global energy prices, but that its role is to prevent higher inflation from becoming persistent and leaving lasting effects on the economy.

The Iran conflict has kept oil prices elevated after the effective closure of the Strait of Hormuz, a key Middle East shipping route for crude. CNBC reported that U.S. President Donald Trump and Iranian President Masoud Pezeshkian electronically signed a 14-point memorandum of understanding on Wednesday intended to establish the basis for a durable peace settlement after four months of war.

Central banks face renewed price pressure

The U.K. decision followed a Federal Reserve meeting at which U.S. rates were also kept unchanged, with the federal funds rate held at 3.5% to 3.75%. CNBC reported that U.S. equities fell after investors reacted to hawkish signals from Kevin Warsh’s first meeting as Fed chair.

Other major central banks have already tightened policy in response to the energy shock. The European Central Bank raised its key rate last week, while the Bank of Japan lifted its policy rate on Tuesday to 1%, its highest level in 31 years, according to CNBC.

Luke Bartholomew, deputy chief economist at Aberdeen, said he believed the Bank of England could avoid the tightening already begun by the ECB and signaled by the Fed. He said that if energy prices continue to moderate, the discussion could return to rate cuts, though possibly not until next year.

George Brown, senior economist at Schroders, said the central bank could not be complacent about inflation risks. He said the threshold for rate increases remained high because softer labor conditions and weak growth should limit second-round effects, while progress on reopening the Strait of Hormuz could reduce some upside risks to energy prices.

Suren Thiru, chief economist at the Institute of Chartered Accountants in England and Wales, said U.K. monetary policy was at “a crossroads.” He said the U.S.-Iran framework had raised hopes that inflation could cool without further tightening, while renewed hostilities could shift the balance back toward higher rates.

This story draws on original reporting from CNBC Economy.