BoE keeps rates on hold for now, while ECB raises rates again amid surging energy prices

Summary

Bank of England recap

The MPC voted by a majority of 6–3 to maintain Bank Rate at 3.75%, with Megan Greene, Catherine Mann, and Huw Pill again favouring an immediate 25 bps increase. Their concern is that surging energy prices could ultimately feed through into broader goods and services prices.

The statement, however, highlighted greater stability in underlying inflation indicators. Core inflation was 2.6% last month, while labour market conditions continue to loosen.

The Committee also noted that financial conditions had tightened since the conflict began, with further tightening since its July meeting. It said those conditions would ‘help to lean against inflationary pressures’.

Together, these factors appear to have given the majority of the MPC greater confidence that it can wait for clearer evidence of second-round inflation effects before raising rates.

Governor Andrew Bailey warned that the longer energy price volatility persists, the greater the likelihood that it affects domestic price and wage setting, potentially requiring higher interest rates. The Bank’s models showed that inflation could exceed 4% in early 2027 if current pressures persist. According to the Bank’s research, inflation at that level would make second-round effects statistically more likely.

A rate increase remains a possible, and the MPC is prepared to act if elevated energy prices begin to generate more persistent domestic inflation.

The decision to keep rates on hold also marks a divergence from other major central banks. The Federal Reserve raised rates by 25 bps for the first time since 2023 on Wednesday, while the ECB has now raised rates twice since the start of the Middle East conflict.

European Central Bank recap

The ECB unanimously increased each of its three key policy rates by 25 basis points, lifting the deposit facility rate from 2.25% to 2.50%.

Central to the decision was a deterioration in the inflation outlook. ECB President Christine Lagarde said the subsequent rise in inflation, to 3.2% in August, had so far been smaller than the ECB expected, but warned that the price shock was likely to prove more persistent.

The ECB now expects headline inflation to average 3.0% in 2026, 2.5% in 2027 and 2.1% in 2028. While its 2026 forecast was unchanged from June, projections for both 2027 and 2028 were revised upwards. Core inflation is also expected to remain above target, averaging 2.6% in 2027 and 2.3% in 2028.

With the latest developments, the rate hike was a relatively straightforward decision, or to quote Lagarde, a “no-brainer”. The ECB had cut its policy rate by 200 bps points over 12 months. With both actual and projected headline inflation now higher, returning the policy rate to the upper end of the range the ECB considers ‘neutral’ is unlikely, on its own, to make monetary policy excessively restrictive.

The challenge is what comes next. The current inflation shock remains predominantly supply-driven, which limits what monetary policy can achieve beyond dampening demand. Raising rates materially further could therefore move policy into restrictive territory and become harder to justify while the eurozone economy is growing only modestly.

Moving forward

For both the Bank of England and the ECB, the policy outlook will depend heavily on energy markets. In turn, that will depend on oil and gas flows from the Middle East, as well as refining capacity.

Indirect and second-round inflation effects have so far remained relatively contained. However, continued or further supply disruption, particularly in European gas markets, or clearer evidence that higher energy costs are feeding into wages and broader prices could force the BoE to act and push the ECB towards additional rate increases.

That makes the BoE’s November meeting particularly important. Updated inflation and growth forecasts, together with September and October labour market and inflation data, should provide greater clarity on whether the MPC can continue to tolerate temporarily above-target headline inflation while underlying domestic price pressures remain contained.