Expert comment: Bank of England holds base interest rate

Matthew Allen, macroeconomic expert at the University of Salford, comments: “Holding interest rates at 3.75% is probably the most sensible option available to the Bank of England at present, but this is becoming an increasingly difficult balancing act.

“On one side, inflation remains above the Bank's 2% target and renewed increases in global energy prices have created a genuine risk that inflationary pressures will persist. On the other, the UK labour market is weakening, and households and businesses are already dealing with relatively high borrowing costs. Raising rates too quickly risks placing further pressure on an economy that remains vulnerable.

“The difficulty for the Bank is that higher interest rates cannot solve the underlying cause of the latest inflation shock. Increasing Bank Rate will not bring down the global price of oil. What it can do is prevent those initial price increases from becoming embedded throughout the economy through higher wages, prices and inflation expectations. 

“For households, another hold provides some stability, particularly for mortgage holders and borrowers who had previously been hoping that interest rates would continue falling. 

“Unfortunately, expectations of significant rate cuts now look increasingly distant. Higher borrowing costs will also continue to affect businesses, potentially squeezing investment, recruitment and growth.

“I would therefore be cautious about raising rates unless there is clearer evidence that the energy shock is feeding into broader and more persistent domestic inflation. The Bank is effectively stuck between two risks: acting too aggressively could weaken growth and employment further, while doing too little could allow inflation to become entrenched again. 

“For now, holding rates gives policymakers time to assess which of those risks is becoming the greater threat. But if oil and energy prices remain elevated, the debate may soon shift from when interest rates will fall to whether they need to rise again.”

Dr Maria Paola Rana, macroeconomic expert at the University of Salford, adds: “The Bank of England’s widely expected decision to keep interest rates unchanged at 3.75% reflects the difficult balance it faces between bringing inflation under control and avoiding further pressure on households, businesses and the wider economy.

“Yesterday’s inflation figures showed CPI (Consumer Prices Index) inflation rising from 2.9% in July to 3.1% in August, moving further above the Bank’s 2% target. However, much of this increase has been driven by higher petrol, diesel and energy prices linked to the continuing conflict in the Middle East.

“There was therefore some reassurance beneath the headline figure. Core inflation remained unchanged at 2.6%, while services inflation was also stable at 3.4%. This suggests that, so far, the energy shock has not led to a significant increase in underlying domestic inflation.

“This helps explain why the Bank has decided to wait. Higher UK interest rates cannot bring down global oil and gas prices. The Bank’s main concern is instead whether higher energy costs begin to spread more widely through the economy, feeding into wages, firms’ prices and inflation expectations.

“The Monetary Policy Committee voted six to three to hold Bank Rate at 3.75%, with three members favouring an immediate increase to 4%. This was exactly the same split as at the previous meeting. So, while the vote has not changed, the Bank’s message has become much clearer: interest rates may need to rise if global energy costs remain volatile and inflationary pressures persist.

“This comes against a changing international backdrop. The US Federal Reserve raised interest rates by 0.25 percentage points yesterday, while the European Central Bank made a similar move last week, amid growing concerns about inflation and higher energy prices.

“In the UK, meanwhile, borrowing costs are already beginning to rise even though the Bank of England has kept Bank Rate unchanged. Major lenders have increased fixed mortgage rates as financial markets increasingly expect UK interest rates to rise in the coming months. For households buying a home or approaching a remortgage, the effects of expected future rate rises are therefore already starting to be felt.

“Markets are now anticipating the possibility of a Bank of England rate increase as early as November, followed by further increases next year if inflation remains persistent.

“In a surprise move, the Bank also announced that it will pause the sale of the £488 billion of UK government bonds, or gilts, that it still holds. These bonds were originally purchased to support the economy during periods of crisis, particularly following the global financial crisis and during the Covid pandemic. The Bank has now set out a longer-term plan to gradually reduce these holdings rather than selling large amounts into financial markets at a time when government borrowing costs are already under significant pressure.

“For households, the Bank of England may have kept rates on hold today, but the financial pressure is far from on hold.”