Bank of England raises rates for first time in three years as ECB holds steady

Summary

Bank of England recap

Rising inflation prompts the first rate increase since 2023

The BoE’s 25-basis-point increase was fully anticipated by markets. Until now, most MPC members had resisted calls to tighten policy in response to renewed inflationary pressures, particularly those driven by rising energy costs. The latest forecasts, however, prompted a shift. The BoE now expects consumer price index (CPI) inflation to reach approximately 5% by mid-2027 as higher oil, gas and refined-product prices feed into household and business costs.

Despite the deteriorating outlook, policymakers see limited evidence that higher energy prices have significantly affected wage growth or broader domestic inflation. This distinction remains important in determining whether additional tightening will be necessary. Bailey emphasised that the latest decision does not necessarily signal a prolonged tightening cycle. “Today’s increase shouldn’t be seen as the first in an inevitable long sequence of hikes. But unless the conflict in the Middle East is resolved, neither does it seem to be the last increase.”

Bailey also pointed to stronger-than-expected UK economic activity and signs of stabilisation in the labour market. Both developments reduce some of the downside risks associated with tighter monetary policy.

Policymakers signal the potential for further tightening

Several MPC members indicated that additional rate increases may be needed to bring inflation sustainably back to target. Megan Greene suggested that further tightening would likely be necessary, while Clare Lombardelli supported the possibility of another near-term increase unless inflationary pressures ease. Huw Pill expressed a stronger view, arguing that a single 25-basis-point increase would likely be insufficient. These comments reinforced expectations that the BoE may act again in December. Following the announcement, markets priced in approximately a 50% probability of another rate increase at the next meeting.

The broader market reaction was influenced by a sharp decline in oil prices following significant Democratic gains in the U.S. midterm elections. Sterling swap rates remained largely unchanged on the day, while the pound struggled to extend its recent gains against the U.S. dollar and euro. The key takeaway: The BoE has shifted towards tighter policy, but the pace and extent of further increases will depend on whether elevated energy costs translate into sustained domestic inflation.

European Central Bank recap

ECB holds rates as inflation risks increase

The ECB left its three key interest rates unchanged at its October meeting, maintaining the deposit facility rate at 2.50% following September’s 25-basis-point increase. Markets interpreted the decision as a hawkish hold, reflecting continued concern about inflation rather than a meaningful shift towards a more accommodative policy stance.

The Governing Council acknowledged that energy prices had continued to rise since September, increasing inflation risks while weighing on economic growth. However, underlying inflation remained broadly stable, and wage growth had yet to show a significant response to higher energy costs. These conditions gave policymakers room to assess incoming data before taking further action.

Higher energy prices complicate the policy outlook

Since the September meeting, the euro area’s inflation outlook has weakened. Headline inflation rose to 3.8% in September before reaching 4.0% in October, driven primarily by energy inflation, which accelerated to 20.8%. Core inflation, which excludes energy, food, alcohol and tobacco, remained unchanged at 2.5%. This suggests that higher energy costs have not yet translated into a broader acceleration in domestic inflation. The distinction presents a difficult policy trade-off for the ECB.

Higher energy prices increase the risk that inflation becomes more persistent, potentially supporting additional rate increases. At the same time, elevated government bond yields and tighter financing conditions are already weighing on economic activity. Lagarde confirmed that policymakers had discussed raising rates at the October meeting but ultimately chose to wait for more information. The ECB’s communication nevertheless remained relatively hawkish. Policymakers emphasised that the scale and duration of the energy shock could increase the risk of indirect and second-round inflation effects, particularly if higher costs begin influencing wages, services prices and inflation expectations.

The key takeaway: The ECB remains concerned about inflation but has more flexibility to wait than the BoE. Stable core inflation and tighter financial conditions support a measured approach, even as headline inflation continues to rise.

Looking ahead: December decisions hinge on inflation persistence

Both central banks face the possibility of further tightening in December. Their decisions will depend largely on whether energy prices stabilise and whether higher costs begin to influence broader inflation.

For the BoE, the latest communication points to a continued willingness to raise rates. Several MPC members have indicated that further tightening may be required, while Bailey has cautioned against assuming that the latest increase will be the last.

For the ECB, October’s rise in headline inflation to 4.0% strengthens the case for another increase. However, stable core inflation and already restrictive financial conditions provide reasons for caution. Even if the ECB raises rates in December, the move could be followed by an extended pause or mark the end of the tightening cycle, particularly given the effect of higher government bond yields on euro-area financing conditions.

What matters most for the rate outlook

The central question for both institutions is whether the current energy shock remains concentrated in energy prices or spreads into domestic inflation. Stable core inflation and wage growth would give policymakers greater flexibility to proceed cautiously. Conversely, accelerating services inflation, wage growth or inflation expectations would strengthen the case for additional tightening, even at the risk of weaker economic activity. For market participants, this distinction is critical. Further rate increases could influence borrowing costs, interest rate hedging decisions and financing strategies, while changes in market expectations may create additional volatility across yield curves. The December meetings will therefore be important not only for the immediate direction of policy rates but also for understanding how each central bank balances inflation risks against slowing growth.

The bottom line: Both the BoE and ECB appear prepared to accept some near-term economic weakness to prevent energy-driven inflation from becoming more persistent. However, the path ahead remains data-dependent. Monitoring core inflation, wage growth and inflation expectations will be essential to understanding the timing and extent of further rate increases.