Energy Price Shock Triggers Bank of England Warning on Higher Interest Rates

The Bank of England has warned that higher interest rates are increasingly likely if energy prices persist at current levels. Deputy governor Clare Lombardelli said prolonged high energy costs could feed into wages, inflation expectations, and businesses' pricing decisions, forcing the central bank to consider raising borrowing costs.

Lombardelli stated that indirect effects from high energy prices could build, causing inflation expectations, wage bargaining, and price-setting behavior to adjust. This could lead to tighter monetary policy unless there is clear evidence that inflation is falling or economic activity is weakening.

The Bank of England's Monetary Policy Committee has already voted to keep the base rate at 3.75%, with Lombardelli among six members who opposed a reduction. The central bank expects inflation to rise to about 3.7% in the fourth quarter of this year and 4.2% in the first quarter of 2027 due to higher energy costs.

The scale and persistence of the energy shock remain uncertain, making it difficult for policymakers to determine their eventual response. However, Lombardelli warned that if households and businesses respond to high energy bills by demanding larger wage increases or raising prices, an initially temporary energy shock could become embedded in domestic inflation.