Interest rates have been held at 3.75% for the fifth successive time but the Bank of England indicated that it was prepared to hike them should the war in Iran go on for longer.
The decision followed a split vote on the Bank’s Monetary Policy Committee (MPC) with six voting in the favour of keeping the rate steady, while three called for an increase to 4%.
The majority of members felt that holding rates at 3.75% was sufficient protection against the risk that increased global energy prices will drive inflation higher later this year.
But the committee “recognised the potential need for additional policy restraint” should further pressures on inflation materialise, and found that there “remains scope for the outlook to change materially as events in the Middle East unfold”, according to the minutes from the latest meeting.
This indicates that interest rates could be raised in response to further re-escalation of the US-Israel’s conflict with Iran.
Governor Andrew Bailey said: “If the conflict in the Middle East persists for an extended period, for an example, and we begin to see signs of emerging second-round effects, it’s likely that we will have to tighten policy to counter inflationary pressures in the UK economy.
“Similarly, if the conflict is credibly resolved in the coming months the paths would point to a looser policy stance than implied by the market curve.”
Asked about whether the outlook for the economy was more positive than the MPC’s last report in April, Mr Bailey said: “The world, particularly the situation in the Middle East, feels as uncertain and volatile today as it did then.”
The central bank said UK inflation had been falling but was expected to rise again later this year as higher energy prices feed through into the economy.
Forecasts also suggested that food inflation is set to tick higher later this year as supply issues linked to hot and dry weather weigh on prices for shoppers.
The Bank predicted that UK inflation will average around 3% this year, before slowing to 2.7% in 2027 and 1.8% in 2028.
It suggested that Consumer Prices Index (CPI) inflation – which was recorded at 2.6% last month – is likely to peak around 3.2% later this year, before steadily easing back towards the Bank’s 2% inflation target.
In last month’s MPC meeting, the Bank had suggested inflation would peak at “slightly above 3.25%”.
Higher oil prices linked to the Middle East conflict are expected to be the main driver of inflation, pushing energy prices higher for households and businesses in the coming months.
The Bank has predicted that households will see a marginal rise in energy bills from October because of a new energy price cap.
In July the price cap rose to £1,663 for the annual electricity bill of a typical household. This is expected to increase to £1,680 in October, the Bank said.
It added that this is around £45 lower than would have been the case without the Government’s decision temporarily to remove VAT on household electricity bills.
The move is expected to have knocked 0.1 percentage points off the inflation rate in the second half of this year.
The Bank also cautioned that a memory chip supply shortage, linked to high demand from the AI sector, could also add to inflation.
The shortage is expected to push technology prices higher and, therefore, “add a little over 0.1 percentage points to UK consumer price inflation” by the end of the year.
Food inflation has slowed in recent months but is expected to swing higher again, to nearly 3.5% by the end of the year, although this is weaker than previous estimates.
The rise in food prices is linked to higher energy bills for food producers and supply issues caused by hot and dry conditions linked to the El Nino weather phenomenon.
Meanwhile, the central Bank also suggested that the UK economy is likely to grow by 1.1% both this year and next year in its central forecast.
It points to a slightly stronger outlook after the Bank previously pointed to 0.8% growth in 2026 in its previous full projections in April.
The picture for unemployment is also slightly improved, with the Bank suggesting this will reach 5.3% next year, having predicted it could be 5.5% in 2027 in its most positive projection from April.
Economist Suren Thiru said a September rate rise was “on the table” after the Bank’s 6-3 policymaker vote.
The chief economist at the Institute of Chartered Accountants in England and Wales said: “The tighter vote split in favour of this outcome confirms a further hawkish shift within the committee with inflation worries outweighing concerns over the economy, keeping a September rate rise on the table.
“Interest rates remain on a knife edge.
“Policy could stay unchanged for the rest of the year, with rate-setters relying on tough talk rather than higher rates to contain inflation.
“But the longer the Iran conflict persists, the greater the risk that the committee’s patience finally snaps.”
Read MoreWhy the Bank of England kept interest rates the same and what could happen next
Here's why new fronts seem to be opening up across the Middle East
Turkey wants to join a new Lebanon security initiative after UN mission ends
Jaguar Land Rover set to cut jobs amid overhaul
FTSE 100’s early promise fades as Bank of England holds rates
