Nikka Sulton

The Bank of England has kept interest rates unchanged at 3.75%, but its latest economic outlook suggests households could be facing another period of rising inflation and borrowing costs.

The Monetary Policy Committee (MPC) again voted to maintain the current rate, with three members supporting an increase. However, the Bank’s accompanying forecasts pointed to growing concerns over the impact of higher energy prices on inflation.

Inflation Forecast Raised

The Bank now expects CPI inflation to reach around 3.75% during the final three months of this year, up from its previous forecast of 3.2%.

Inflation could then rise above 4% early next year as higher energy costs feed through into household bills and the wider economy.

The Bank also expects the Ofgem energy price cap to increase by 4% during the final quarter of this year. A much larger rise of around 24% is forecast for the first quarter of next year, potentially adding hundreds of pounds to the average household energy bill.

These projections come as oil, gas, diesel and other energy prices have risen sharply following increased military activity in the Gulf and disruption to a major oil pipeline from Saudi Arabia.

Higher Rates Could Return

The Bank’s latest assessment is more concerning than the headline decision to leave interest rates unchanged might suggest.

Its previous economic forecasts included alternative scenarios showing how the economy could perform under better or worse conditions. The Bank now believes the recent energy price shock means the UK economy is moving closer to its more adverse scenario.

Under that scenario, inflation could reach 4.1% by this time next year, while interest rates could eventually rise to 4.25%.

Economic growth would also be weaker over the following year or two.

Although the Bank has not committed to raising rates, the combination of higher energy costs and persistent inflation means economists increasingly expect further rate increases in the months ahead.

What Could This Mean for Households?

Higher inflation could put renewed pressure on household finances, particularly if energy bills rise substantially.

For homeowners and prospective buyers, higher interest rates would also increase the cost of mortgages and other borrowing. Landlords could face additional pressure if financing costs rise while tenants continue to struggle with affordability.

The situation remains heavily dependent on what happens to energy markets. A sustained rise in oil and gas prices could keep inflation elevated, while a reversal in prices could reduce some of the pressure.

Bank Plans Changes to Quantitative Tightening

The interest rate decision was not the only significant announcement from the Bank.

It is also considering changes to its quantitative tightening (QT) programme, which has been used to gradually unwind the large-scale government bond purchases made during the financial crisis and pandemic.

Since 2022, the Bank has been reducing its holdings of government bonds. However, the process has created challenges for both financial markets and the public finances.

Selling large quantities of gilts can contribute to higher bond yields, which can feed into borrowing costs across the economy. Some of the bonds have also been sold for less than the price originally paid, creating losses for the Bank.

The Bank now faces another issue as it approaches the remaining bonds in its portfolio. Some could be difficult to sell without accepting significant losses if there is limited demand from financial markets.

Proposed Change to Bond Sales

The Bank has proposed transferring some of these bonds to the government’s Debt Management Office rather than selling them directly into financial markets.

The proposal is technically complex and could attract close attention from investors, particularly while bond yields remain elevated and economic conditions are uncertain.

The impact on financial markets remains unclear.

For now, the key message from the Bank is that although interest rates have been left unchanged, the outlook has become more challenging. Rising energy prices could push inflation higher and increase pressure for further rate rises, adding another layer of uncertainty for households, borrowers, buyers and landlords.