BoE holds rates while ECB tightens policy amid renewed inflation concerns

Summary

Bank of England

Today’s BoE decision showed the Monetary Policy Committee is continuing its cautious approach to the dual risks of higher inflation and weaker growth. Policymakers acknowledged that, while inflation has moderated from its recent highs, risks remain elevated due to geopolitical developments and their potential impact on energy markets. Meanwhile, a softer U.K. labour market and weak growth should help limit second-round effects, and progress on reopening the Strait of Hormuz should also reduce some of the more extreme upside risks to energy prices.

When commenting on his vote to leave interest rates on hold, Andrew Bailey said market pricing showed rising British government borrowing costs over time. That reflected more "risk premia" than interest rate expectations alone, he said, without elaborating on whether he meant British political risks or other factors, such as global inflation concerns. Bailey also said the Bank remains prepared to respond quickly should energy-price shocks begin feeding into broader inflation expectations, even as the underlying domestic economy shows signs of slowing.

The GBP weakened across the board following the decision, but particularly against the U.S. dollar, following the more hawkish than expected Fed rate decision. U.K. interest rate swap curve eased by 5-7 bps.

 European Central Bank

The ECB proceeded with a well-telegraphed rate hike, seeking to avoid surprising the market with its monetary policy decisions. The decision was unanimous among the governing council. President Lagarde said it was “pretty obvious” the central bank needed to raise rates, as the conflict in the Middle East resulted in a “major energy shock” that lasted longer than expected and was beginning to  affect the wider economy.
In May, consumer prices across the Eurozone rose to 3.20%, remaining above the ECB’s 2.0% target for the third consecutive month.

Unlike the U.K., where rates remain restrictive, eurozone monetary policy has increasingly been viewed as close to neutral following a series of rate cuts over the past two years. This provided the ECB with greater flexibility to respond to renewed inflation risks. The ECB simultaneously revised its inflation forecasts higher and its growth projections lower. Under its latest baseline scenario, inflation is expected to average 3.0% in 2026 before gradually returning toward target. Meanwhile, growth forecasts were reduced, reflecting the impact of higher energy prices on consumer spending and business activity, alongside weaker sentiment due to global instability. Market reaction was relatively measured given the move had been largely anticipated. However, EUR swap rates moved modestly higher, and market pricing now suggests investors see a greater chance of further tightening should inflation continue to surprise on the upside.

Moving forward

Looking ahead, markets expect the BoE to keep rates on hold at 3.75% through the summer, with policymakers closely monitoring energy markets, wage growth, and inflation expectations. A hike is expected by the end of the year but likely remains highly data dependent. Furthermore, given that just two MPC members currently favor rate hikes, the hurdle for raising rates looks high.

For the ECB, attention will focus on whether June's increase proves to be a one-off adjustment or the beginning of a broader tightening cycle. The ECB were steadfast in their approach to policy decisions being totally data dependent. Further increases remain possible if inflation continues to exceed projections, although weaker growth dynamics and lower energy prices, if sustained, could ultimately limit the extent of additional action.