The Bank of England's cautious response to rising inflation risks keeping interest rates higher for longer, according to the National Institute of Economic and Social Research. The thinktank said the monetary policy committee's recent increase in the base rate from 3.75% to 4% was too timid and that inflation could remain above the Bank's 2% target until at least 2030 unless the central bank took tougher action. The Bank raised rates last week and signalled another increase to come as it battles inflationary pressure linked to the Iran war.
UK inflation currently stands at 3.5%, well above the Bank's target, driven higher by soaring fuel costs. Oil and gas prices have risen sharply since the end of February when the US and Israel launched military action against Iran. Brent crude oil has traded persistently above $100 a barrel in recent weeks, compared with around $70 before the conflict, though it dipped below $90 on Tuesday after Donald Trump suggested military action against Iran might not be necessary at present.
David Aikman, director of the Niesr, warned that inflation was set to rise above 4% in the new year just as most pay awards for 2027 are being agreed, creating a risk that inflation becomes embedded in the economy. He urged the Bank to be more aggressive, noting that "one further quarter-point rise is unlikely to be enough, and the longer the MPC waits, the more it will eventually need to do." The thinktank said all the ingredients were in place for workers to demand inflation-linked salary rises.
The Niesr's forecasts for UK growth were based on oil prices at $105 a barrel. Even with recent price declines, the institute cautioned that continued difficulties in shipping and refining meant consumer prices would decline slowly. Stephen Millard, an economist at the institute, noted that lower oil prices depended on Trump maintaining his new policy stance. "We've seen him change his mind before," he said.
The thinktank expects the UK economy to grow by 1.6% this year but only 0.9% in 2028 as high inflation, elevated interest rates and tight government spending weigh on consumer and business confidence. Aikman said there was a "double whammy" from higher energy prices and rising global borrowing costs that was not being addressed. He warned that financial markets would punish the Treasury by raising the price of loans to the UK if government spending soared in areas such as defence without offsetting savings elsewhere.