Bank of England to play for time as war brings inflation heat

Bank of England Pauses Interest Rate Cut Due to Ongoing Inflation Risks

Bank of England's Cautious Approach Amid Global Uncertainty

By William Schomberg

LONDON, March 16 (Reuters) - The Bank of England will choose its words even more carefully than usual this week alongside its expected decision to delay an interest rate cut in the face of inflation risks from the war in the Middle East.

Still stung by criticism that it and other central banks moved too slowly when Russia's full-scale invasion of Ukraine drove British inflation above 11% in 2022, the BoE will be wary of missteps.

Governor Andrew Bailey and his colleagues can only wait to see how long the U.S.-Israeli war on Iran lasts, and how persistent the jump in oil and gas prices will be.

That means bets on a rate cut on Thursday, at the end of the Monetary Policy Committee's March meeting, are now off.

Economists polled by Reuters mostly expect a 7-2 vote by the MPC to keep Bank Rate at 3.75%. Before the start of the war on February 28, a cut to 3.5% was seen as a near certainty.

Inflation Outlook and Economic Risks

Inflation Now Seen at 3-4%

Britain's economy was facing a risk of weak growth and stubborn inflation pressures even before the crisis in the Gulf, which has once again exposed the country's heavy reliance on imported natural gas.

Analysts say the direct impact of higher energy prices is likely to push British inflation to about 3-4% by the end of 2026, if oil and gas prices stay at current levels, up from previous forecasts of around 2%, the BoE's target.

More worrying for the central bank, it could also drive up the public's still elevated inflation expectations, making it harder for the BoE to say it will look through any short-term inflationary effects.

A Reuters poll of economists last week showed no consensus on when the BoE was likely to cut Bank Rate.

Dani Stoilova, UK and Europe economist with BNP Paribas Markets 360, said she thought only one more cut was possible, and only if oil prices fall from their level now of around $100 a barrel to under $80.

"There might still be a pathway for them to deliver a final rate cut to 3.5% over the next few months, but it's looking narrower and narrower by the day," Stoilova said.

Other economists expect two cuts in the next six months.

Shifting Policy Guidance

Change the Message

The scale of the uncertainty means the BoE is likely to change its guidance on borrowing costs.

At its two previous meetings, the MPC said "on the basis of the current evidence" rates were likely to fall further.

Analysts at Barclays said the BoE was now likely to drop that line and instead emphasise another part of its guidance that "the extent and timing of further easing in monetary policy will depend on the evolution of the outlook for inflation".

Market and Investor Reactions

Investors will pore over individual comments from MPC members to try to get a sense of how far their views have moved.

Edward Allenby, senior economist at Oxford Economics, said they were likely to be vague.

"We think the MPC will be very conscious about the risks of making major policy errors and the potential hit to credibility should the committee be forced into a policy reversal," he said.

Investors last week priced in the possibility of borrowing costs going up, not down.

But for now at least, most economists think the BoE is less likely than the European Central Bank to pivot to rate hikes.

At 3.75%, Bank Rate is relatively high, the economy is struggling to grow, unemployment is rising and finance minister Rachel Reeves has raised the tax burden to its highest since just after World War Two.

"I think the Bank is going to play for time which, when things are so uncertain, makes sense," Paul Dales, chief UK economist with Capital Economics said.

(Writing by William SchombergEditing by Gareth Jones)