Bank of England Governor Andrew Bailey warned on Thursday that policymakers are facing the “most difficult combination” of rising prices and slowing economic activity, as surging energy costs threaten to embed inflation in the economy.
Speaking after the central bank held its benchmark interest rate steady at 3.75 percent, Bailey said the outlook remains highly uncertain, particularly as energy markets react to the ongoing Iran war.
“This is what we would call a negative supply shock,” Bailey said, referring to a scenario in which higher input costs both push up inflation and weigh on economic growth. “That’s a difficult combination.”
The Bank of England’s Monetary Policy Committee voted by an 8–1 majority to leave rates unchanged, with only chief economist Huw Pill dissenting in favour of a modest rate increase.
The decision comes as inflation in the United Kingdom remains above the bank’s 2 percent target. Official data showed consumer prices rose 3.3 percent year-on-year in March, up from 3.0 percent the previous month, driven largely by higher fuel costs.
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Bailey cautioned that if elevated energy prices persist, their impact could spread more broadly across the economy, influencing wages, production costs and consumer prices.
“If we see this pass-through becoming embedded and persistent, we will have to respond,” he said, signalling that further monetary tightening remains a possibility.
The central bank also warned of so-called second-round effects, where workers seek higher wages to offset rising living costs, potentially creating a cycle of sustained inflation.
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Prior to the recent surge in energy prices, markets had widely expected the Bank of England to begin cutting interest rates in 2026 as inflation eased. However, those expectations have shifted, with investors now pricing in the possibility of rate hikes later in the year.
Analysts say the bank faces a delicate balancing act. Raising rates could help contain inflation but risks further slowing an already fragile economy, while holding rates steady could allow price pressures to become entrenched.
The UK economy has shown signs of uneven growth in recent months, with households under pressure from higher borrowing costs and elevated living expenses.
Bailey said the central bank would closely monitor how energy prices feed through into the broader economy, including their impact on the labour market and overall demand.
The Bank of England noted in its latest assessment that inflation is likely to rise further later this year as the full effect of higher energy prices filters through supply chains and consumer bills.
Despite the uncertainty, Bailey stressed that returning inflation to target remains the bank’s primary objective.
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“Getting inflation back to 2 percent is critically important,” he said, underlining the central bank’s commitment to price stability.
The situation highlights the broader challenges facing central banks globally, as geopolitical tensions and commodity price shocks complicate the path of monetary policy.
For the Bank of England, the coming months are likely to hinge on whether energy-driven inflation proves temporary or becomes more persistent — a distinction that will determine whether policymakers are forced to tighten policy further in a bid to maintain credibility and economic stability.
