BoE set to hold at 3.75% as UK inflation holds at 2.8%

UK inflation defied expectations of an acceleration in May, reinforcing the case for the Bank of England to keep rates on hold.

The Bank of England is expected to keep its key rate at 3.75% on Thursday after UK inflation unexpectedly held at 2.8% in May, defying forecasts of a pickup to 3%.

"Today's data strengthens the case for a continued cautious approach from the bank," said Yael Selfin, chief economist at KPMG U.K.

Motor fuel costs rose 25% from a year earlier, the Office for National Statistics said Wednesday, while food inflation fell to its lowest since December 2024. Services prices also picked up, with air fares jumping 10.3% between April and May, though the ONS noted the earlier timing of Easter this year may have influenced that figure.

The BoE in April forecast inflation would rise to a little over 3.5% by year-end before retreating, though a more severe scenario saw it exceeding 6% in early 2027. A US-Iran deal to reopen the Strait of Hormuz has since eased energy price expectations, prompting Pantheon Macroeconomics to withdraw its call for a July rate rise and instead expect the BoE to stay on hold through 2027.

The unchanged reading marks the first time since late 2024 that UK inflation has not risen month over month, breaking a streak that had pushed the annual rate from 1.7% in September 2025 to 2.8% by April. A 13% rise in the cap on home-energy prices planned for July suggests upward pressure will persist even after the Strait of Hormuz deal, though the extent depends on how quickly oil flows normalize through the choke point.

Energy Prices and the Strait of Hormuz

Energy prices fell sharply Sunday after the US and Iran announced the agreement on social media, though they have not returned to pre-conflict levels. The deal prompted traders to pare back rate-hike expectations in the swaps market, with Pantheon Macroeconomics removing its forecast of a July increase. Both the UK and the eurozone are net energy importers and remain exposed to oil and natural gas price swings. The European Central Bank raised its key rate last week, judging the energy price jump too significant to ignore — a contrast with the BoE's more patient stance.

What Comes Next for Rates

Markets have rolled back expectations of tighter policy since the Hormuz announcement. Overnight-indexed swap pricing implies the BoE will hold through the remainder of 2026 and into 2027, according to Pantheon Macroeconomics, which on Tuesday removed its forecast of a rate increase in July. BoE Governor Andrew Bailey said last month the bank could tolerate inflation temporarily above target, suggesting the threshold for a hike remains high.

The last time the BoE faced a similar energy-driven inflation spike — following Russia's invasion of Ukraine in 2022 — it raised rates at 14 consecutive meetings, taking Bank Rate from 0.1% to 5.25%. This cycle, the central bank has been more measured, holding at 3.75% since cutting from 4% in February 2026.

This article is for informational purposes only and does not constitute investment advice.