Bank of England hikes rates to 4% as Iran war inflates prices

Inflation in the United Kingdom hit 3.5% in September, an 11-month high that forced the Bank of England to raise its benchmark interest rate to 4%.

The Monetary Policy Committee, a group of nine officials, voted to increase the rate by 0.25 percentage points. This marks the first hike in more than three years. The previous rate was 3.75%, and the last adjustment occurred in August 2023.

Policymakers had previously been lowering rates from a 15-year peak of 5.25%. The reversal is a direct response to energy prices, which have surged due to the ongoing war with Iran. The conflict has created bottlenecks in the Strait of Hormuz, a critical chokepoint for global oil and gas transport. These supply disruptions have raised fuel costs, which in turn have increased prices for consumers across the economy.

The UK's inflation rate is now 1.5 percentage points above the central bank's target of 2%. Ellie Henderson, an economist at Investec, stated that many committee members' patience with the rise in inflation has worn thin. She warned that if energy prices remain elevated, a temporary price shock could become a permanent feature of the economy.

The Bank released quarterly economic projections alongside the rate decision. These forecasts are more uncertain than usual because of the volatile geopolitical situation. The economic outlook now depends heavily on developments in the Iran war and the subsequent impact on global energy markets. Higher interest rates make borrowing more expensive, which is intended to reduce spending and bring inflation under control.

A key variable in the current calculation is the recent fall in energy prices. This drop followed heavy losses by the Republican Party in the U.S. midterm elections. If the decline in oil and gas prices continues over the coming weeks, the upcoming peak in inflation may be lower than previously feared. Such a development could temper expectations for further rate hikes.

The Bank of England is not acting alone. The U.S. Federal Reserve and the European Central Bank have recently raised their own interest rates in response to similar inflationary pressures. The timing of this move follows a period where UK rates had been on a downward trend since the U.S. and Israel attacked Iran on February 28. The conflict disrupted the previous easing cycle, forcing a rapid reassessment of economic risks.