The Bank of England held interest rates at 3.75% on Thursday after voting unanimously to sit tight as surging energy prices driven by the Middle East conflict pushed the UK inflation outlook sharply higher.
The Monetary Policy Committee (MPC) warned that consumer price inflation could rise from the 3% seen in January to around 3.5% by the third quarter of the year, almost 1.5 percentage points above the Bank's 2% target.
The immediate trigger was the disruption to oil and gas supplies flowing through the Strait of Hormuz, the key Gulf shipping lane, which has almost ground to a halt following Iranian attacks on vessels attempting transit.
Wholesale gas prices were around 60% above their pre-conflict levels in the run-up to Thursday's meeting, though still well below the peaks reached after Russia's invasion of Ukraine in 2022.
The MPC said monetary policy could not influence global energy prices but would aim to ensure inflation returned sustainably to its 2% target.
It flagged risks that higher energy costs could embed inflationary pressures through wages and prices, but could equally weaken an already fragile economy and push unemployment higher.
The MPC said it would reassess the situation at its next meeting in six weeks.
In the minutes from the meeting, the BoE dropped its previous guidance from February that "on the basis of the current evidence, Bank Rate is likely to be reduced further".
Instead, the minutes said: "developments over the next six weeks could shed light on the likely scale and duration of the conflict, as well as providing some early evidence on the likely propagation of the shock.
"There was a range of possibilities for how monetary policy might need to respond to different developments and risks. A larger or more protracted shock, which risked greater second-round effects in wage and price setting, would require a more restrictive policy stance.
"Conversely, policy would need to be less restrictive if the shock was very short-lived, or if there were to be a larger opening up of slack in the economy that was expected to reduce medium-term inflationary pressures. The MPC would act as necessary to ensure the 2% target was met sustainably."
Decision as expected, comments seen as tilting hawkish
The decision was in line with City economists' expectations.
It "makes sense given the enormous uncertainty enveloping the global economy in the wake of the escalating war in the Middle East", said economist Kallum Pickering at Peel Hunt.
"The 9-0 unanimous vote in favour of holding the Bank Rate is the most credible outcome possible given the extremely difficult backdrop – and reflects an honest appraisal of the situation the BoE faces, in our view.
"While rate-setters may still privately believe that the next rate move is more likely to be down than up, given the uncertainty over the Iran war timeline, advocating for such a move would have been unwise."
He said the BoE’s next move seems to depend entirely on the duration of the Iran war, the related disruption to global energy markets, and how much that could lift UK inflation and depress economic output and employment.
"For now, then, the BoE is in what we would describe as ‘development-dependent’ mode and will react with its policy to how the war unfolds."
Following the publication of the decision and minutes, losses on the FTSE 100 deepened, with fifteen stocks dropping down more than 5% and another 14 down over 4%.
Miners were taking the heaviest beating due to a combination of falling metal prices and risk-off sentiment, while banks were down sharply as investors worry about the impact of a global slowdown on loan books and credit quality. Housebuilders were among the fallers on the prospect of rates remaining elevated for longer, while engineers and retailers were also hit.
"If anyone was in doubt as to how the BoE would respond to the current situation, then today is clear. A dramatic shift has taken place, and hikes are back on the table," said Chris Beauchamp, market analyst at IG.
As he adds, this was pretty much unthinkable just a few weeks ago, "but is a sign of how the war with Iran has upended everyone's forecasts".
Deutsche Bank economist Sanjay Raja said the key line from Threadneedle Street was that all MPC members were "ready to act as necessary to ensure that CPI inflation remained on track to meet the 2% target in the medium term", and refrained from maintaining an easing bias.
Raja said: "The probability of hikes will have risen meaningfully following today's decision with all members noting that they will know more by the April decision.
"In some way, this is the new and important benchmark. If we get no clarity or resolution on the war, we will likely see a pivot in policy. Put simply, rate hikes are now a real risk for the economy."
He said there is now "a lot of pressure for fiscal policy to respond to guard against rate hikes" and "Chancellor Reeves' timeline to respond has been shortened".
** UPDATE: Adds reaction and comments **