The Bank of England will almost certainly hold interest rates at 3.75% at its meeting next week, most likely in a 7-2 vote. Current market pricing implies England have about twice as much chance of actually bringing home the world cup trophy than the Bank of England does of raising interest rates next week.

That seems fair, and not just because England might have a chance this time. The picture of the war in Iran has improved since the last meeting with oil prices dropping below $90pb for the first time since April amid hopes of a deal and signs of demand destruction in Asia. If oil prices remain at current levels, there will be little need for the Bank to respond, giving the Monetary Policy Committee (MPC) plenty of room to delay any action once again.

However, the split on the MPC is growing. There is a good chance that two members vote for a rate hike next week given the Straits of Hormuz remain closed and surveys suggest underlying price pressures are rising sharply. We expect there will be an element of “talking the talk” with the guidance not pushing back against market pricing of two rate rises this year and emphasising that the committee remains “ready to act”.

Further ahead, we think a weakening labour market and deteriorating economic outlook will keep the Bank on hold this year before cutting three times in 2027. But the risks are clearly weighted to at least one rate hike in the summer. The crucial point will be whether there is evidence of second-round effects emerging.

Economic data justifies a "wait and see" approach

Most of the recent data has had a dovish tinge to it as far as the MPC is concerned. The labour market has weakened with the unemployment rate rising to 5% in March, payrolls falling sharply in April (although that will be revised) and private sector pay growth coming in weaker than expected. At the same time, inflation has slowed more sharply than expected and services inflation has dropped to 3.2%, below the MPC forecast of 3.4%. Admittedly, growth was robust in Q1, coming in a littler hotter than expected. But the recent survey data has dropped sharply, with the services PMI dropping to 49.3, the first sub-50 reading since April 2025, and GDP probably contracted in April.

What’s more, oil prices are significantly lower than at the time of the last meeting on anticipation of an imminent deal to reopen the Straits of Hormuz and signs of increased demand destruction in Asia. Admittedly, natural gas prices are a little higher than the assumption used in the MPC’s scenario B, which most members seemed to put most weight on. Fortunately, the MPC now know that the energy price cap will rise by 13% in July, providing some near-term certainty until Q4 when the cap is next changed.

The weakness in data flow will give the majority of the committee plenty of reassurance that “wait and see” is the right course of action. That will allow them to focus more on the “stag” part of the stagflationary shock. In any case, a simple Taylor rule suggests that rates are already modestly restrictive, which means the MPC doesn’t have to hike rates to weigh on inflation.

However, oil and gas prices are still well above their pre-crisis levels, suggesting there is a significant amount of further energy inflation in the pipeline. Survey measures such as the PMI suggests firms are planning to hike prices aggressively to protect their margins as our chart below shows, although the Bank’s DMP survey is much more moderate. Household’s long-term inflation expectations have also risen to 4% in May, from 3.6% in February, which will worry some on the committee that employees will try to bid up wages to protect their real incomes. But this is below the March reading when expectations surged to 4.5%, so households seem to be less worried about the inflationary shock now that the initial impact on fuel prices has filtered through.

Ultimately, the recent data suggests that the economy is slowing in response to higher fuel prices, which will lessen the risk of second round effects emerging. Given the recent drop in energy prices and the weak data flow there is little reason for the Bank to rush into rate hikes next week. Indeed, we see Governor Bailey as the key swing voter and he recently reaffirmed that “Given the softness in the real economy and uncertainty around the scale and duration of the shock, tolerating temporarily above target inflation to provide some support for the real economy is an appropriate way to approach the trade-off” which sums up the wait and see approach.

That said, the MPC won’t want to push back too hard against market pricing, which is tightening financial conditions in the economy and doing some of their work for them. That means the guidance will probably keep an emphasis on “ready to act” and highlight the risk of second-round effects emerging or energy prices rebounding. We expect this “talk the talk, but not walking the walk” approach to continue for the rest of the year.

Three cuts in 2027

Indeed, unless there is a substantial rebound in energy prices, we think the MPC will keep rates on hold for the rest of the year, while keeping a tightening bias in the communications. Although, risks are clearly skewed towards hikes in the coming months. Next year, assuming energy prices don’t surge again, we think the MPC will be able to cut three times as inflationary pressures drop back sharply and the high unemployment rate creates spare capacity in the economy.

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