It was no surprise that the Bank of England raised interest rates by 0.25 percentage points to 4% last week. However, it made it pretty clear that more rate hikes are likely and that rates will probably stay higher for longer. Meanwhile, the blue wave in the US midterm elections could bring new geopolitical risks for the UK economy and markets.

Interest rates set to stay higher for longer

The recent surge in energy prices, which has partly unwound in the last few days, means the Bank now expects inflation to rise to almost 5% in the first half of next year. Having made that forecast, there was no way it could avoid hiking interest rates in response – after all, the Monetary Policy Committee’s (MPC) target is to keep inflation at 2%. With most of the observation window for January’s Ofgem price cap already complete, household energy bills are still likely to rise by around 25% despite recent falls, which will push inflation up sharply.

It wasn’t just energy prices that prompted the Bank to hike rates. Dave Ramsden emphasised that: “Activity has proved more resilient than expected, slack in the labour market is levelling off, and private sector wage growth has stopped declining. These less favourable starting conditions increase the risk of second-round effects.” In short, the stronger economy has increased the likelihood of higher energy prices spilling over into price-setting and wage bargaining, which would make the shock even more persistent.

The big question is: what comes next? Here there was a bit of a surprise. The hawkish comments in the minutes made it clear that most MPC members expect to raise rates further. Governor Bailey probably summed it up best: "Without news which softens the risks to inflationary pressures, I can see the argument for a further increase in rates." So, unless energy prices fall dramatically and stay down over the winter, another rate hike looks like a sound bet. February is the most likely timing for the next hike, but we can’t rule out back-to-back hikes in December. That’s quite a turnaround given that almost half of the committee was talking about potentially resuming rate cuts just six weeks ago.

Beyond that, we think rates can stay on hold for the rest of 2027, but that will depend heavily on how energy prices develop over the winter. To quote Governor Bailey again, "today's rise shouldn't be seen as the first in an inevitable long sequence," but unless the Middle East conflict is resolved, "neither does it seem likely to be the last."

A resumption of fighting in Iran that pushes energy prices higher again could easily result in a third hike. Conversely, it would take a pretty spectacular drop in energy prices to take a December or February hike off the table.

US midterms: a blue wave with global ripples

That leads nicely on to the potential impact of the spectacular blue wave in the US midterms. I have avoided saying too much on this, mainly because Trump is an unpredictable character at the best of times and will be even more so now. But we have already seen some consequences in global financial markets, and there are some potential risks worth bearing in mind.

The midterm result could mean that President Trump seeks to assert his authority in foreign policy, where the election makes little difference to his powers. Indeed, if the rest of his presidency is bogged down by congressional investigations and his domestic agenda is stifled, he may decide to pull the only lever left to him: foreign policy. Many “lame duck” presidents before him, including Obama, have gone down this route, so it is clearly worth considering.

How that might play out is speculation, but there are some obvious areas on our radar. A resumption of fighting in Iran is probably the most consequential, although the recent drop in oil prices suggests markets do not think that is particularly likely. However, the risk is that, no longer restrained by an imminent election, Trump might escalate the conflict. Democrats’ ability to block or constrain Trump’s options on Iran is greater now, but still limited. Renewed strikes on Iran could easily push oil prices above $120 per barrel, given that global buffer stocks have already been eroded.

Next on the list is the Russian invasion of Ukraine. Trump could try to bring the war to a quicker end. The immediate economic implications are probably limited, assuming the EU continues to boycott imports of Russian gas. But it could still have significant implications for European governments’ willingness to boost defence spending. Less relevant for the global economy, but certainly not for the people involved, would be an attempt by Trump at regime change in Cuba.

Aside from military action, President Trump may also fall back on his favourite policy weapon – tariffs. This is more difficult given that many of his previous attempts have been struck down by the courts. But we would not be surprised to see another round of ad hoc tariffs pop up over the next two years.

Finally, while the midterm results probably don’t change much at the national level, given that Trump can still veto any legislation he doesn’t agree with, the shifts at state level may have a bigger impact. Many politicians campaigned against data centres, and fears of tighter AI regulation contributed to the rout in tech stocks last week.

To reiterate, Trump is unpredictable and is arguably just as likely to focus on his golf game as on renewing the war with Iran. But the risk is that the final two years of his presidency become a period of increased geopolitical uncertainty.

Oil prices have fallen sharply over the past week or so, from $117 per barrel to around $97. The decline appears to be largely driven by the US midterm result. The Republican loss has been widely seen as a rebuke of the administration's handling of the Iran conflict, and Vice President Vance acknowledged voter frustration over fuel prices, reinforcing expectations of a policy shift.

If sustained, lower oil prices should feed through to pump prices, bringing some relief to UK households and businesses. That could mean inflation peaks around 4.7% next year rather than at almost 5% as the Bank expects, so real incomes and profit margins would come under less pressure than we previously thought.

Bank of England Governor Andrew Bailey noted last week that oil prices are already at a level the Bank wasn't expecting until May 2027. That could give the Bank a little more leeway over how far it needs to raise rates in the coming months.

Admittedly, refining margins remain elevated, which will keep fuel prices higher than the usual relationship with oil would suggest.

Nonetheless, lower oil prices should take some of the sting out of fuel prices over the coming months, helping to limit the rise in inflation.

We expect the UK economy to have grown 0.1% in September.

On the details, we expect industrial production to fall by 0.5% in September. All four industrial sectors are likely to see output fall back, but the main driver will be manufacturing, which we expect to drop by 0.5% after a couple of strong months.

Elsewhere, we think the downturn in the construction sector continued through September. Admittedly, the PMI improved from 44.3 to 46.1, but it remains well below the 50 mark consistent with stable output. Brick deliveries also remain chronically weak, suggesting housebuilding is still subdued, so we expect output to fall by a further 0.1% in September.

The good news is that we expect the services sector to have grown by 0.2% in September. IT and administrative services output should rise solidly, even after a few strong months over the summer, especially as underlying demand in the IT sector looks to be supported by AI uptake. Elsewhere, a rebound in hospitality and in arts and recreation output after a weak August should more than offset the drop in retail sales, leaving consumer-facing services ticking up in September.

Ultimately, we think the economy sustained its momentum into the autumn, which should deliver 0.7% growth for Q3 as a whole. We then expect growth to slow to around 0.2% in Q4 and remain subdued into Q1 2027, as inflation climbs towards a peak of around 5%, dragging on real incomes, and higher financing costs continue to feed through to the real economy.

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