Bank of England to hold rates as UK inflation hits 3.1%

The Bank of England is widely expected to leave its key interest rate unchanged on Thursday. Markets see an over 80% chance of a hold, according to LSEG data, despite inflation rising to 3.1% in August.

This decision would set the UK central bank apart from its major peers. The US Federal Reserve announced a quarter-point hike on Wednesday. The European Central Bank raised rates last week, and the Bank of Japan is anticipated to do the same on Friday.

Inflation driven by fuel costs

Data from the UK's Office for National Statistics showed the annual inflation rate climbed to 3.1% in August. This marks the first time it has exceeded 3% since March. The ONS said the increase was largely driven by a 23% year-on-year surge in motor fuel costs.

As a net energy importer, the UK remains vulnerable to external energy price shocks. The country is still dealing with a cost-of-living crisis stemming from post-pandemic inflation and the impact of the Russia-Ukraine war on natural gas supplies.

Market pressure and gilt yields

Global inflation concerns and political instability have pressured UK government bonds, known as gilts, this year. Britain currently has the highest borrowing costs in the G7. Yields on long-dated 20- and 30-year gilts are approaching 6%.

Earlier this week, The Telegraph reported that the Bank of England would announce plans to stop selling these long-dated gilts alongside its rate decision.

Analyst views on the policy path

Analysts suggest the latest inflation data is unlikely to trigger an immediate rate hike. Scott Gardner, an investment strategist at J.P. Morgan Personal Investing, said the increase was "unlikely to convince the Bank of England to hike interest rates just yet." He warned it could raise fresh concerns about the inflation outlook among policymakers.

Gardner noted that higher energy costs from the U.S.-Iran conflict, which began over six months ago, are still filtering through to business and household expenses.

Shreyas Gopal, an FX strategist at Deutsche Bank, said the absence of hawkish surprises in recent UK labor and inflation data had been enough for market pricing for a September hike to fall back. Markets now widely anticipate a hike of at least 25 basis points at the Bank's next meeting in November.

The Bank of England has not changed its key rate this year. Its last move was a 25-basis-point cut in December.