Bank of England holds rate at 3.75% and sets 8-year plan to unwind £488B in gilts

Interest rate decision and vote split

The Bank of England Monetary Policy Committee voted 6-3 on Thursday to keep its benchmark interest rate unchanged at 3.75% for the sixth consecutive meeting. Three minority members voted in favour of an immediate increase to 4.0%. The rate decision diverged from recent moves by international peers, leaving the benchmark rate at its level established late last year after earlier falling from a 15-year peak of 5.25%. Economists surveyed prior to the announcement had largely anticipated the hold because domestic wage growth and labor market indicators remained comparatively soft. David Rees of Schroders observed that softness in the domestic economic backdrop should limit the spillover of external price pressures into local wages.

That should limit the extent to which imported price pressures become embedded in domestic wages and prices.

Inflation forecasts and energy price pressure

Official figures released on Wednesday showed that the United Kingdom consumer price index rose to 3.1% in August from 2.9% in July, driven by higher prices for vehicle fuel and airfares. Bank of England policymakers warned that British inflation is now projected to exceed 4% early next year as prolonged conflict in the Middle East sustains elevated energy costs. Brent crude oil has traded above $100 a barrel following disruptions linked to the Iran war and the closure of the Strait of Hormuz to maritime transit. The central bank noted that scheduled 4% increases in household energy bills in October will add further near-term pressure. Governor Andrew Bailey addressed the risks posed by sustained energy volatility during the announcement.

So far higher global energy costs have had a limited effect on price and wage setting in the UK. But the longer this volatility persists, the bigger the impact it will have on inflation, and the more likely it is we will need to raise Bank Rate to ensure that inflation falls back to our 2% target.

Overhaul of quantitative tightening

Alongside the interest rate decision, the Monetary Policy Committee voted 9-0 to approve an eight-year program to eliminate the central bank's remaining £488 billion in government bonds held for monetary policy purposes. Under the framework, the bank will permanently retain £120 billion in gilts maturing in 2049 or later to back physical banknotes, while £222 billion maturing by 2034 will mature passively off the balance sheet. The remaining £146 billion will be sold at an active pace of £20 billion annually, yielding an overall reduction rate of £46 billion per year. Active bond sales will pause entirely until April while central bank officials conduct market consultations, and sales of long-dated gilts have ended permanently following recent rises in 30-year borrowing costs to levels unseen since 1998.

Global policy divergence and market reaction

The policy pause contrasts with tightening actions by other central banks, including the US Federal Reserve's rate increase on Wednesday, its first in more than three years, and the European Central Bank's second post-conflict rate hike. Financial markets priced an estimated 65% probability of a Bank of England rate increase at its November meeting and a 75% chance of two hikes occurring before the close of 2026. Following the announcement, sterling was little changed at $1.3387 and traded near 85.70 pence against the euro. British Prime Minister Andy Burnham noted after the latest inflation data release that the government remains prepared to make necessary fiscal decisions ahead of the national budget scheduled for 28 October.