BoE and ECB hold rates, signal readiness to act on inflation

Summary

Bank of England

While the BoE’s decision to hold rates was in line with market expectations, the MPC language was viewed as less hawkish, considering inflation has re-accelerated and oil prices have moved back above $100 per barrel in recent days.

Their decision reflects a complex domestic backdrop. UK inflation has risen to 3.3%, driven largely by higher energy and utility costs, and is now expected to increase further in the near term. GDP growth remains subdued, while consumer confidence and labour demand have softened, helping to dampen wage-driven inflation pressures.
Governor Andrew Bailey emphasised that “higher inflation is unavoidable” in the short term due to global energy shocks. He outlined scenarios where inflation could peak above 6% under an extreme scenario, where oil prices remain elevated and natural gas prices double.

Governor Bailey said he placed most weight on the middle scenario, under which second-round effects on inflation would be minimal and only modest rate increases would be needed to bring inflation back to target.
The BoE’s chief economist, who voted to hike rates by 25 basis points (bps), said that in all scenarios, there are risks of “second-round effects” that warrant higher rates.

Following today’s decision, GBP swap rates are down by around 10 bps out to three years. This suggests that markets do not expect the BoE to tighten policy immediately, although rates remain roughly 100 bps above their level at the start of March.

European Central Bank recap

The ECB also opted to hold rates, with the main lending rate at 2.0%, extending its pause as it assesses the evolving inflation outlook. The ECB continued to frame current policy as closer to neutral, providing flexibility to tighten if necessary and said that a rate hike had been discussed at today's meeting.

It said it would closely monitor events in the Middle East and take a data-dependent and meeting-by-meeting approach to its monetary policy decisions, emphasizing it would not pre-commit to a particular rate path.

Prior to the announcement, data released this morning showed that Eurozone inflation rebounded more than expected to 3.0% in April, the highest level since September 2023. Meanwhile, economic growth slowed to 0.1% in the first quarter of 2026, down from 0.2% in the previous quarter.

Recent surveys have also shown that inflation expectations have jumped, while consumer and economic sentiment have both decreased, adding to a challenging backdrop for setting monetary policy.

Moving forward

Prior to the war with Iran, the BoE were seen continuing their gradual monetary policy easing, with disinflation supporting a less restrictive policy stance. Markets have since revised their expectations, shifting from expecting rate cuts to anticipating renewed tightening.

Given the risks to economic growth from the likely squeeze on consumers caused by higher food and fuel costs, the BoE will be reluctant to hike. For now, developments in the Middle East are therefore set to dominate the policy debate, although a two-month closure of the Strait of Hormuz could mean that ship has already sailed.

Previously, markets expected the ECB to Keep policy rates  unchanged this year while signaling a readiness to raise them if energy-related inflation were to rise unexpectedly.

Markets are now pricing in around three ECB rate hikes this year, with the first potentially coming in June. As with the Bank of England, policymakers will want greater confidence that energy price shocks will prove persistent, whether wage growth is accelerating, and that consumer demand and labour markets remain resilient. Even so, if tensions in the Middle East continue, they may be forced to act regardless.