BOE's Pill urges rate rise as war keeps inflation above 2%

The Bank of England should raise its key rate above 3.75% to stop war-driven energy costs from locking in inflation above target, Chief Economist Huw Pill said Thursday, arguing that waiting for clarity on the Middle East conflict risks letting price pressures spread through wages and corporate pricing.

"Raising Bank Rate on this basis need not be the start of a prolonged and aggressive series of increases," Pill said in a speech in Edinburgh. "Even if a new ceasefire were announced tomorrow, experience suggests we would be hard-pressed to assess its effectiveness, how long it might last and what would follow its expiry."

Pill was one of three Monetary Policy Committee members who voted for a rise at the July 30 meeting, against six who backed holding the rate at 3.75%. He has favored a higher level for borrowing costs than his colleagues for months, voting for a 25-basis-point increase at both the April and June meetings. UK annual inflation stood at 2.9% in July, above the BOE's 2% target, and is expected to pick up in coming months as home energy prices rise.

The backdrop is a war between the US and Iran that began with attacks on Feb. 28, with Iranian blockades in the Strait of Hormuz choking one of the world's most critical energy chokepoints. UK natural gas prices have surged more than 70% since the conflict began, while petrol prices have climbed roughly 10%. The BOE's scenario analysis projects inflation could peak as high as 6.2% in early 2027 if elevated energy prices persist, with a more moderate baseline of 3.2% to 3.5%.

Pill's case rests on the risk of second-round effects — businesses passing higher input costs to consumers and workers demanding pay to keep up — even as the labor market loosens. Unemployment has risen to roughly 5% to 5.2%, with the output gap estimated at about 1% of potential GDP. He argues that slack alone will not neutralize those pressures, and that acting now is preferable to moving more aggressively once the next round of pay negotiations begins in early 2027.

Some MPC members counter that the rise in government bond yields since the war began has already tightened financial conditions, removing the need for the central bank to act. Pill rejected that logic, warning that because higher yields partly reflect expectations the BOE will lift rates, a hold could lead investors to price cuts in 2027. "In this setting, the market will ease financial conditions just when the MPC needs them to tighten," he said.

Investors still expect the MPC to leave the rate at 3.75% when it meets later this month, leaving Pill in a minority. The divergence extends beyond the UK: the European Central Bank is expected to deliver its second rate rise since the war began next week, and the Federal Reserve may soon join central banks that have tightened in response to higher energy prices. That gap in policy paths has kept gilt yields elevated relative to euro-area and US peers, a spread Pill's argument implies could narrow only if the BOE moves.

The last time the BOE confronted a comparable energy-driven inflation shock, after Russia's invasion of Ukraine in 2022, it delivered 14 consecutive rate increases before inflation peaked above 11%. The current tightening cycle is far less aggressive, but Pill's warning echoes that episode: waiting for certainty on a war's course risks letting a temporary price spike become a persistent one. If energy prices keep climbing, the market's expectation of a hold could prove as short-lived as the ceasefire Pill doubts would hold.

This article is for informational purposes only and does not constitute investment advice.