Bank of England rate-setters already grappling with unpredictable US trade policy and unreliable UK data now face a fresh oil price shock as they meet this week to set borrowing costs in the wake of Israel’s air strikes against Iran.
The potential for prolonged conflict and disruption to energy supplies would make the BoE’s Monetary Policy Committee even more inclined to caution at a meeting where it was already widely expected to hold interest rates at 4.25 per cent, economists said.
Fallout from the air strikes on Friday would also make it even harder for the committee — deeply divided since its nine members split three ways in May — to convey a clear sense of how far or fast it might lower rates in future, they added.
Jens Larsen, a former BoE official now at the Eurasia Group consultancy, said the Israel-Iran conflict was the latest in a sequence of geopolitical shocks making it difficult to set monetary policy around the world.
“The Bank of England has said it will respond to the volatile geopolitical environment and repeated shocks by making greater use of scenarios to communicate all the uncertainty out there,” he said.
“But so far this is very much a work in progress. It is hard to discern a clear narrative from the BoE on the outlook — they can’t afford to just throw up their hands and say they have no idea what is going on.”
When the MPC cut rates by a quarter-point in May in a 5-2-2 vote, it repeated its guidance that it would take a “gradual and careful” approach to further monetary loosening. Markets have interpreted the wording as pointing to a 0.25 percentage point cut in interest rates each quarter.
But the committee has rarely been so divided in its thinking. The last time there was a unanimous vote on monetary policy was in September 2021, when rates were at a historic low of 0.1 per cent.
Last month, the MPC split three ways, with BoE chief economist Huw Pill joining external member Catherine Mann in voting for rates to be kept at 4.5 per cent, while fellow external members Swati Dhingra and Alan Taylor backed a jumbo half-point cut.
Even among the five-member majority, the decision was “finely balanced”, according to minutes of the meeting, with some members, including governor Andrew Bailey initially minded to hold rates and swayed at the last minute by US President Donald Trump’s sweeping “liberation day” tariffs.
The intense geopolitical uncertainty is only one reason why the MPC is so divided. The committee is also struggling to determine whether the UK economy — which suffered a fresh setback in April, with a 0.3 per cent drop in output — is on the brink of big job losses, or whether workers are still well-placed to press for wage rises that could fuel inflation.
Doubt over the quality of crucial economic data is making it harder to answer these questions: in recent evidence to MPs, Bailey called attention not only to well-flagged problems with jobs data, but also to increasing volatility in GDP figures, and a “puzzle” in official data showing productivity had fallen in a way “usually associated with quite serious recessions”.
Analysts are increasingly frustrated by the lack of clarity in the BoE’s own messaging.
Andrew Wishart, senior UK economist at Berenberg, said one problem was that rate-setters appeared reluctant to comment too explicitly on the extent to which government tax policy had hit jobs.
Bailey’s own reticence also made it harder to gauge the MPC’s direction of travel, Wishart said, with the governor giving “high-level” speeches on themes such as globalisation rather than a clear steer on his thinking.
“It’s hard to pin him down . . . and since he is effectively the swing voter on the committee, that does make it much more tricky,” Wishart added.
The BoE says that it wants to explain the uncertainties around its forecasts by making greater use of scenarios, setting out how inflationary pressures could evolve in different situations and force it to vary its policy approach.
But analysts say the two scenarios set out in May’s monetary policy report have shed little light on the committee’s thinking — especially since MPC members do not necessarily align their own views with either scenario.
“The scenarios haven’t really been particularly helpful,” said Andrew Goodwin, at the consultancy Oxford Economics, adding that they “felt like a box-ticking exercise” to follow up on the recommendations of a highly critical review by former US Federal Reserve chair Ben Bernanke.
Rob Wood, chief UK economist at consultancy Pantheon Economics, agreed that the experiments with scenarios had not yet paid off.
“It amounts to saying inflation could be higher or lower than you think,” he said. “Maybe it will improve over time, but I don’t think it is saying very much.”
Economists are hoping the BoE will give a clearer steer on Thursday, following a run of weak data that will lessen the worries about inflation persistence. But if the Israel-Iran conflict triggers a sustained rise in oil prices it will only heighten the difficult trade-offs faced by the MPC.
Headline inflation already remains far too high for comfort, even allowing for an error that overstated April’s 3.5 per cent reading by 0.1 percentage point.
On the other hand, figures showing continued job cuts and a clear slowing in wage growth could allow for a change in tone, with some MPC members becoming more open to an August rate cut. Weak GDP figures on Thursday could also point to softening demand.
“All members of the MPC have put the labour market at the centre of their deliberations,” said Jack Meaning, economist at Barclays. “The fact that wage growth is now at risk of undershooting the committee’s May forecast . . . should shift the balance of risks.”
Goodwin said: “Anyone who was wavering will now be in the cut camp in August.”
Better BoE communications, which Bernanke called for just over a year ago, would help clarify how policy will evolve, analysts said.
Rate-setters “produce a lot of words, there are a lot of press conferences and appearances at the [House of Commons] Treasury Committee”, Wood said. “All those words and appearances still leave me pretty confused about what they think.”