BoE's Bailey says energy price pass-through remains limited, rate risks persist

Most economists now expect the Bank of England (BoE) to begin raising interest rates next month.

According to the report, Bailey said the evidence of wider price pressures remained subdued, with businesses focusing heavily on cutting costs and struggling to pass higher energy expenses on to customers.

Most economists now expect the Bank of England (BoE) to begin raising interest rates next month, according to a Reuters poll, after the central bank kept monetary policy unchanged following the outbreak of the US-Iran war in February.

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The BoE held its benchmark interest rate at 3.75% last month, with six members of its Monetary Policy Committee voting to keep rates unchanged and three favouring a different decision. Bailey was among the majority but had indicated that monetary tightening could become necessary if the risk of second-round inflation effects increased.

Speaking at a meeting of the Institute of International Finance in Bangkok, Bailey said policymakers needed more time to determine whether the initial energy price shock would translate into broader and more persistent inflation.

Bailey said his discussions with businesses across Britain suggested that companies were prioritising cost reductions and facing difficulties in passing higher energy costs on to consumers. This has so far limited the evidence of wider price pressures stemming from the energy shock, the report stated.

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The governor has previously argued that the sharp increase in British mortgage rates and other borrowing costs since the start of the US-Iran war had given the central bank some time to assess whether an interest rate increase was necessary.

However, other BoE policymakers have warned that waiting for conclusive evidence of second-round effects could leave the central bank behind the curve. Annual pay settlements expected in early 2027 could provide a clearer indication of whether higher energy costs are feeding into wages and sustaining inflation.

Bailey also said the British economy was proving more resilient than policymakers had anticipated. Data released on Thursday showed that annual economic growth in August was the strongest since October 2022, providing a more encouraging picture of economic activity despite persistent price pressures, as per the report.

Nevertheless, inflation remains a significant concern for the central bank. Bailey described the August inflation rate of 3.1% as deeply frustrating, as it remained well above the BoE's 2% target. He attributed the overshoot primarily to conflicts in the Middle East, which have pushed energy prices higher.

The geopolitical turmoil has also contributed to volatility in British government bond markets. Bailey said developments in the Middle East were the principal driver of sharp movements in government bond yields, some of which reached their highest levels since 1998 last week, Reuters reported.

The BoE faces a difficult balancing act as it weighs the risk of persistent inflation against the potential impact of higher borrowing costs on households and businesses. A rate hike could help contain inflation expectations, but it could also put pressure on mortgage borrowers and companies already facing higher costs.

Bailey's remarks suggest that policymakers remain cautious about drawing firm conclusions from the initial impact of higher energy prices. The extent to which businesses pass on costs, workers seek higher wages and inflation expectations rise will be crucial in determining the timing and scale of any further monetary tightening.

The Institute of International Finance meetings are being held in Bangkok alongside the annual meetings of the International Monetary Fund and the World Bank, where policymakers and financial leaders are assessing the economic implications of geopolitical tensions, higher energy prices and tighter financial conditions.