BoE holds rates while spelling out hiking scenarios

Highlights: The Bank of England held rates steady at 3.75 per cent, but the tone has clearly shifted. This was less a pause and more of an “active hold”, with policymakers signalling that further tightening remains a real possibility if inflation pressures persist. While growth is showing tentative signs of stabilisation in the UK, the quality of that recovery remains weak and increasingly overshadowed by rising price pressures, particularly from energy. The policy backdrop therefore needs to be finely balanced as central banks are not ready to act immediately, but the direction of risk is still skewed toward higher rates rather than cuts, especially if inflation expectations begin to drift higher. We remain constructive on both conventional and inflation-linked gilts.

• What stands out from the meeting is the shift toward scenario-based guidance, which reinforces a tightening bias. Across all three scenarios presented by the BoE, rates are expected to rise further, with the extent depending largely on the path of energy prices and second-round effects. Although, some members hold a candle for Mervyn King’s “Maradona Theory” – they believe that a significant share of the heavy lifting has been done on their behalf – driven by more hawkish market expectations and tightening financial conditions. In more adverse outcomes, where oil prices remain elevated, inflation can become more entrenched and could require a more aggressive policy response, even as growth weakens and raises the risk of a stagflationary backdrop
• The BoE’s decision to stay on hold reflects a difficult trade-off between soft growth and persistent inflation. Price pressures have re-accelerated across both manufacturing and services, with input and output costs moving back toward levels last seen in 2022, highlighting that inflation is not yet fully under control. Consumer confidence too remains fragile and continues to deteriorate, while the housing market is losing momentum under the weight of higher mortgage rates and affordability constraints
• Policymakers are increasingly focused on inflation expectations, recognising that these will be key in determining the path of policy. While market-based measures have already moved higher, survey-based indicators remain more mixed and are already showing early signs of pressure. If higher expectations begin to feed into wage-setting behaviour, the BoE may be forced to tighten further to maintain credibility, even in the face of weaker growth. We’ve pushed back expectations for the next BoE rate cut to early 2027
• Portfolio implications: Overall, we stay neutral on UK equities as the positives from its defensive tilt are largely balanced by weak domestic growth and limited upside. Within fixed income, we are more constructive as gilt yields already look elevated, which helps limit downside and offers attractive carry, so we see value here. We are positive on conventional and inflation-linked gilts, which provide useful protection given inflation risks are still not fully behind us. On currency, GBP is likely to remain range-bound for now, with some downside risk in more risk-off scenarios