Why the bar is high for the Bank of England to hike rates

Out of all the central banks, it’s tempting to say that the Bank of England is going to be among the most sensitive to the rise in energy prices. That’s certainly the way markets see it.

The repricing to short-term interest rate expectations has been more dramatic for the UK than the eurozone or especially the US. Investors have swung from pricing 50bp of easing in 2026 on the eve of the Iran conflict, to 20bp of rate hikes now. The memories of the 2022 inflation spike are evidently still fresh.

As things stand, if the current price levels endure, we think we’d see inflation spike to around 3.5% by late summer. And that’s before we consider the knock-on effects beyond petrol/diesel and household energy bills.

Yet we think the bar for the Bank to actually hike rates is high. The economic backdrop is very different to 2022. The jobs market is considerably weaker. Vacancy rates are well below pre-Covid levels, and the drop has been more acute than in other developed economies. Wage growth is falling, not rising as it was four years ago.

Back in 2022, the UK economy was also still riding the tailwind of Covid-era fiscal stimulus. It was aided by significant government support, chiefly the £2500 household energy cap, which, together with other measures, amounted to 2% of GDP in FY2022.

This time, fiscal policy is a headwind; the deficit is falling this year, driven by the freeze in tax brackets. Meanwhile, the government’s ability to respond as it did in 2022 is heavily diminished. 10-year bond yields are more than 3 percentage points higher than they were at the time of the Ukraine invasion. And the same is true more or less everywhere; the UK economy isn’t going to ride on the coattails of fiscal stimulus elsewhere, as it was able to four years ago.

The problem in 2022 was that the spike in energy prices morphed into a surprisingly long-lasting and sticky bout of service-sector inflation. All of the above suggests the reaction this time will be more muted. And we think the way the economy reacted to last April’s tax and minimum wage hikes is a case in point.

Take hospitality, a sector that bore the brunt of both the energy price spike in 2022 and last year’s policy changes.

Four years ago, the sector dealt with higher energy bills by hiking prices, rising 15% above trend by late 2023, with minimal impact on employment. Sure, this also coincided with the post-Covid recovery and the staff shortages that came with it. But the sector found itself with some pricing power to pass on the cost hit without impacting jobs.

Last year, the story was very different. Faced with higher payroll taxes and a sharp rise in the National Living Wage, the sector shed jobs at a faster pace. Employment is 1% below the pre-April 2025 trend (a trend that was already pointing downwards). This was a sector that had found itself overstaffed post-Covid (evident in falling productivity), and those policy changes proved to be the catalyst for a reset. Arguably, this process has further to run, and the energy price shock will only amplify that.

Prices, by contrast, have shown very limited reaction. And remember, this all coincided with a period of higher food inflation, an issue for these catering businesses.

That is just one sector, but an important one: it’s often cited as a barometer for underlying economic performance and inflationary pressure. And it’s an important reminder that the risk of second-round wage and inflation from shocks like higher energy prices is much diminished compared to 2022. Most BoE officials were increasingly reaching this conclusion too at the December and February meetings.

So where does that leave the March meeting? A rate cut is clearly off the table, where it had been looking highly likely before the Iran invasion. At a minimum, Governor Andrew Bailey, who would have likely had the deciding vote, will be minded to vote for a pause.

At this stage, it’s too early to say anything sensible about the precise macro implications without knowing how long the conflict and closure of the Strait of Hormuz will last. And with no press conference or forecasts this month, we suspect the Bank will use the policy statement simply to play for time, with forward guidance that says any further rate cuts will depend on the evolution of energy prices and the impact on expectations.

The main question is how many officials do still vote for a cut. We suspect Swati Dhingra and Alan Taylor, both determined doves, will keep doing so. Our base case is for a 7-2 vote in favour of no change. If more officials vote for a cut, then that should help temper the rate hike pricing within markets.

Ultimately, we still think the next move in rates is more likely down than up. If by the time of the April meeting, energy prices have fallen back – say to 70-75 USD/bbl on oil and 35 EUR/MWh on gas – then we think there’s a chance the Bank could still cut rates at that point. Such a scenario would point to headline inflation staying below 3%, which officials would be minded to "look through".

In a scenario where the disruption lasts longer, risking inflation closer to 4%, then the Bank will likely be more cautious. We suspect it would wait and see how firms react in surveys through the summer, on questions like wage growth expectations. That would point to a prolonged pause, but we think we could still see further easing later in the Autumn/into winter.