Bank of England: On hold and a closer vote… but not sounding closer to a hike

The economist view

As expected, the Bank of England’s Monetary Policy Committee (MPC) voted to hold Bank rate at 3.75%. The vote was six-three with Huw Pill and Megan Greene voting for a rate rise joined this time by Mann (consensus: seven-two). They continue to worry about second-round effects but are not to seeing evidence of them yet, helping them to stay on hold rather than hiking. During the press conference, Governor Andrew Bailey said the bank were seeing “clear signs of underlying disinflation in recent data”, and that inflation is now lower than they had forecast in April. They are also taking comfort from looser labour markets and tighter financial conditions since the conflict started. For those who voted to keep rates on hold, tighter financial conditions helped provide “sufficient insurance against the upside risks to inflation.”

After yesterday, we are still assuming that the BoE keep rates on hold this year but still see the risk to that as skewed towards a hike rather than a cut this year. We don’t, however, see them as having really moved closer to a hike at this meeting despite the change in vote from seven-two to six-three, especially having read the individual MPC paragraphs. At one point in the press conference Governor Bailey actually said, “Please do not leave this room thinking that the Bank of England is edging towards a hike.”

We still think there is cause for concern on second-round effects and think that it wouldn’t take much to persuade a majority to hike rates once, as part of a risk-mitigation strategy.

As before though, much will effectively depend on events in the Middle East which remain inherently uncertain (it was notable that all members agreed that risks to the paths of energy prices remained skewed to the upside) and the statement noted the potential for other inflationary shocks, including from food prices (something we have recently highlighted too – see The next inflation storm? Food, fertiliser and El Niño). We still think there is cause for concern on second-round effects and think that it wouldn’t take much to persuade a majority to hike rates once, as part of a risk-mitigation strategy. 

Bringing back the central case (but keeping the scenarios)

Having dropped a central case in the April meeting, the committee members revived it for the July meeting (though it retains less focus than it used to before they reformed their communications). That central case incorporates the 15-day average of energy prices to July 20th and assumes moderate second-round effects. The adverse scenario includes higher energy prices and stronger second-round effects while the milder scenario assumes lower energy prices and no second-round effects.

The central scenario projects inflation to run below target two and three years from now, conditioned on a profile for Bank rate that peaks at 4.2%.

It was notable, however, that compared to the April meeting, the individual MPC paragraphs made little mention of the scenarios aside, perhaps, from Alan Taylor. The central scenario projects inflation to run below target two and three years from now, conditioned on a profile for Bank rate that peaks at 4.2%. Insofar as the central case tells us anything that suggests that, if things evolve broadly in line with their central case, the MPC thinks the market may have at least one too many rate hikes priced in and the title of a related chart in the Monetary Policy Report states bluntly that “The economic outlook in the central projection would be consistent with a looser policy stance than implied by the market curve.”

During the press conference, Bailey, however, noted that the market implied curve “seems a reasonable position for now”, given the balance of risks (where, as he put it, market participants find it most likely that they will be on hold this year but investors require a premium to compensate for risks).

Still energy-focused and still focused on second-round effects

The BoE continues to expect inflation to rise in the second half of the year as higher energy prices feed through more fully and some modest indirect effects materialise, which it estimates will add around 0.5pp to inflation in H2 2026. It continues to worry about second-round effects “against which policy needs to lean”, but so far see “little evidence” of such effects and currently see more signs of disinflation than they had expected. For now, though, it sees upside risk to the inflation outlook compared to its central projection and those who voted to keep rates on hold, “recognised the potential need for additional policy restraint were signs of material second-round effects to emerge”.

The individual comments indicate that despite three voting for a rate hike, some of the MPC sound even less likely to hike than they did previously.

In particular, Bailey, who has been seen at points as a swing voter, saw “tentative evidence that inherited inflation persistence may be weaker than had been presumed.” Sarah Breeden described incoming data as showing “disinflation to have been firmly on track” and as having greater confidence that second-round effects should be limited.

Three camps on the MPC

Aside from Bailey and Breeden, Clare Lombardelli and Swati Dhingra (all voting to keep rates on hold) both view the policy stance as restrictive, while continuing to watch for second-round effects later in the year and wage setting in 2027.

The comments suggest that the remaining MPC members are broadly split into two camps. The first camp, including Taylor and Dave Ramsden, appear comfortable keeping rates on hold for now, but seem more inclined to vote for cuts should energy prices fall, or if evidence of second-round inflation effects remains limited. For instance, Ramsden said “an early assessment of second-round effects suggests they are more likely than not to be limited”, while Taylor said he supported “keeping bank rate on hold…before resuming cuts when and if geopolitical uncertainty clears.

The other camp, including Greene, Catherine Mann and Pill, voted to hike rates, although these votes increasingly look more like insurance against the risk of second-round effects. For instance, Greene said, “I believe a risk management strategy is appropriate” and Mann said, “research emphasises that the costs of leaning against upside risks that fail to materialise would be smaller than the cost of leaning too little against upside risks”.

The fund manager view

At this week’s Bank of England (BoE) meeting, the Monetary Policy Committee (MPC) voted six-three to maintain bank rate at 3.75%, with three members voting for a 0.25% rate hike. When compared to the eight-one vote split seen in May, this slightly hawkish outcome suggests some policymakers are becoming increasingly concerned about future inflation. However, it was reiterated in the press conference, by Governor Andrew Bailey, that disinflation is continuing, household demand is weak, and businesses' pricing power is limited. The Committee is not seeing clear signs of second-round effects feeding into broader inflation, although they do see inflation risks as still on the upside. The Committee pushed back against the idea that the BoE is edging towards tighter policy, reinforcing the BoE’s ‘wait and see’ approach. The market seemed reassured that inflation remains on a path back towards the 2.00% target. 

Since March, the reoccurring cycle of the hope of a peace settlement in the Middle East followed by renewed escalations has meant that market pricing in cash and sovereign bond markets has remained volatile.

Since March, the reoccurring cycle of the hope of a peace settlement in the Middle East followed by renewed escalations has meant that market pricing in cash and sovereign bond markets has remained volatile. Today, the market still has around two rate hikes priced in by April 2027, which is a reflection of geopolitical instability, fiscal uncertainty, and term premia, rather than a reflection of inflation expectations alone. We have moved into a world where the cost of liquidity has pushed money market curves steeper, helped by an enduring lack of trust in central banks. The markets expectation of the neutral rate is now around 4.25%, which we feel would be hard to sustain in an economy where growth forecasts by the International Monetary Fund (IMF) and Organisation for Economic Co-operation and Development (OECD) are barely expected to pass 1% in 2026 and 2027.

The gilt market responded positively to the latest BoE meeting, with front-end gilts leading a sharp rally as investors pushed back expectations of policy tightening.

Against this backdrop, the gilt market responded positively to the latest BoE meeting, with front-end gilts leading a sharp rally as investors pushed back expectations of policy tightening. The curve steepened sharply, benefiting the gilt funds, where we remain overweight the front end of the curve.

In cash markets, yields on certificates of deposit (CDs) have risen considerably since the war escalated, by up to 100 basis points but have remained relatively steady since the last BoE meeting in May, with one-year CDs now achieving yields in excess of 4.50%. Spreads on floating rate CDs (FRCDs) have remained close to historic highs with one-year FRCDs achieving yields close to SONIA + 40 basis points. We feel these levels look attractive, and while we remain somewhat cautious on the outlook for the UK, we feel that investing selectively at attractive levels makes sense in a cash fund. Cash funds are continuing to act as a safe haven in 2026 with strong flows and attractive returns. Persistent concerns about inflation and the conflict in the Middle East, have reinforced the value investors are placing on liquidity.

As ever, we remain open to the opportunities that this environment creates, seeking to remain active and nimble and using our experience and risk managed approach to take advantage of outsized market moves driven by the positioning and actions of other market participants.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.