The risk balance for the UK economy has shifted significantly toward the upside for inflation and the downside for growth following the Bank of England’s decision to hold rates at 3.75% and issue hawkish warnings about the Iran war’s energy price impact. The monetary policy committee voted unanimously to hold on Thursday, but the explicit acknowledgement of a new inflationary shock combined with weak domestic data has created an asymmetric risk profile that complicates the Bank’s forward guidance. Officials warned that inflation could rise above 3% and borrowing costs might need to increase.
The upside inflation risk is being driven primarily by the war’s impact on global energy markets. Rising oil and gas prices threaten to push UK inflation well above the 2% target, potentially to levels that would require a significant monetary policy response. The Bank has revised its near-term inflation forecast upward, with projections now showing inflation rising toward 3.5% in March and remaining elevated throughout 2026.
The downside growth risk is being driven primarily by domestic conditions. Unemployment at 5.2%, slowing wage growth, and sluggish economic activity all point toward an economy operating below its potential and in need of monetary support. Rising energy costs and the prospect of rate hikes add to the downside growth risk by reducing household disposable income and increasing the cost of business borrowing.
Governor Andrew Bailey acknowledged both dimensions of the shifted risk balance. He said the Bank was giving careful consideration to the combination of inflation risk and growth weakness and had concluded that holding rates while monitoring developments was the appropriate response. His message was that the Bank was alert to both risks and would not ignore either in formulating its policy response.
Financial markets focused on the upside inflation risk. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as traders priced in the inflationary consequences of the war. Analysts noted that the asymmetric risk balance — with inflation to the upside and growth to the downside — was itself a source of uncertainty that would take time to resolve.