The Bank of England’s decision to hold rates at 3.75% on Thursday underscores the profound challenge facing the UK economy in 2025: navigating a slowing domestic economy while managing an external inflation shock triggered by war in the Middle East. The monetary policy committee voted unanimously to hold, but warned that the energy price surge caused by the US-Israel conflict against Iran could push inflation above 3% and force borrowing cost increases within months. The decision reflects a central bank caught between conflicting economic signals.
UK domestic conditions had been pointing toward monetary easing. Unemployment rose to 5.2% in the latest data, wage growth slowed sharply, and economic activity remained subdued. Ordinarily, these indicators would have supported a rate cut at this meeting. But the Iran war has introduced a competing consideration — the risk of a new inflation spike driven by global energy market disruption.
Governor Andrew Bailey outlined the Bank’s dilemma frankly, noting that the most effective solution to the inflation threat would be a resolution of the conflict and a restoration of energy supply chains, both of which lie outside the Bank’s power. Within its mandate, the Bank would monitor conditions carefully and use rate policy if the inflation situation required a response. For now, that meant staying on hold.
Markets did not share the governor’s patience. UK gilt yields rose, the FTSE 100 fell, and the pound gained against the dollar as traders priced in the prospect of tighter policy. June is now widely viewed as a possible date for the first rate hike, with a second potential increase before year end. Mortgage rates on five-year fixed deals have already moved to multi-year highs.
The challenge for policymakers is likely to intensify in the coming weeks. New inflation data will test whether the energy shock is feeding through as quickly as feared. Any escalation of the Middle East conflict could accelerate the timeline for rate action. The Bank’s next meeting has already taken on heightened significance in the minds of analysts and investors.