The Bank of England’s inflation-fighting credibility is being tested by the Iran war, as the institution voted unanimously to hold rates at 3.75% on Thursday while acknowledging that rising energy prices could push inflation above 3% for an extended period. The monetary policy committee’s response to the challenge was to hold and warn rather than act, a stance that reflects genuine uncertainty about the duration of the shock but that also carries risks for the Bank’s credibility if inflation proves more persistent than anticipated. Officials warned that the conflict represented a significant new threat to UK price stability.
The credibility test comes from the potential for inflation to remain above target for an extended period while the Bank delays action. The UK has already experienced five years of above-target inflation, and MPC member Megan Greene specifically noted that this had left households and businesses unusually sensitive to further price increases. If the war prolongs the period of above-target inflation, the Bank’s failure to act more decisively could be questioned.
Governor Andrew Bailey defended the Bank’s approach by emphasising the genuine uncertainty about the war’s consequences and the importance of gathering more evidence before acting. He said the Bank retained both the tools and the will to respond if inflation became persistent, and that the current stance of holding represented appropriate caution rather than inaction. His credibility argument rested on the Bank’s record of eventual action when circumstances required it.
Financial markets are already delivering their verdict on the credibility question by pricing in rate hikes in June and later in the year. UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar as investors bet that the Bank would ultimately be forced to act. The market’s pricing could itself become a test of credibility — if the Bank fails to follow through on the expectations it has generated, its authority over future market expectations could be weakened.
The credibility question will become more acute if inflation rises toward or above 3% in the coming months while the Bank continues to hold. At that point, the pressure to act will intensify and the cost of inaction in terms of public and market trust will rise. Thursday’s decision was defensible as a first response to a new shock, but the Bank’s credibility will ultimately depend on how it acts in the meetings that follow.