The hold and the split
The Monetary Policy Committee held Bank Rate at 3.75 percent in June by a 7-2 vote, with the dissenters reflecting the genuine difficulty of the decision. The Bank is caught between two of its objectives pulling in opposite directions: inflation has risen toward 3.3 percent and sits above target, arguing against cuts, while growth has been marked down below 1 percent, arguing for them. The 7-2 split - rather than a unanimous hold - signals a committee that knows it is in a bind and is buying time, waiting to see whether the energy-driven inflation pickup proves transitory or whether it leaks into a more persistent wage-price dynamic.
The conflicted reaction function
The Bank's reaction function is the hardest in the G7 because its problem is a supply shock and its tools are built for demand. An energy-driven inflation pickup that coincides with weak growth gives the Bank no clean move: cutting to support growth risks entrenching above-target inflation and damaging credibility, while holding or hiking to fight inflation deepens the growth squeeze. The Bank has prioritised credibility - its memory of the 2022-2023 inflation overshoot is fresh - and is therefore biased toward holding rather than easing into the softness, accepting weaker growth as the price of getting inflation back to target. That bias makes it more hawkish, at the margin, than its growth outlook alone would imply.
The Bank of England is fighting the last war on purpose. Having been criticised for being slow on the way up in 2022, it is determined not to be slow on the way down - which means it will tolerate a weaker economy to be sure inflation is beaten. For gilt and sterling investors, that is a more hawkish reaction function than the growth data alone would suggest.
Transmission to gilts and sterling
The reaction function transmits to a gilt market that is among the highest-yielding in the developed world: 10-year gilts near 4.76 percent and 30-year yields around 5.47 percent reflect both the sticky-inflation, hold-biased Bank and a substantial term and fiscal premium. Sterling has been relatively supported by the Bank's reluctance to ease - a higher-for-longer Bank Rate gives the currency a yield advantage over peers that are cutting - though that support is tempered by the weak growth outlook. The gilt market's elevated long-end yields are the clearest expression of the UK's predicament: a central bank that cannot ease, a fiscus that must consolidate, and a term premium that prices both.
| Horizon | Most likely | Rationale |
|---|---|---|
| Jun 2026 | Hold (done) | Inflation up, growth down |
| H2 2026 | Hold | Wait for inflation to peak and fade |
| 2027 | Cautious cuts | Only as inflation returns to target |
| Risk | Later, slower easing | If wages/energy keep inflation sticky |
Scenarios for the policy path
Our base case is an extended hold at 3.75 percent through 2026, with the Bank cutting only cautiously in 2027 as inflation returns toward target - a later and shallower easing path than the weak growth would otherwise justify, because credibility comes first. The dovish case requires the energy shock to fade quickly and wage growth to slow decisively, opening the door to earlier cuts. The hawkish tail is a wage-price spiral that keeps inflation above 3 percent and forces the Bank to hold even longer or hike, deepening the growth squeeze. For gilt investors the message is to expect higher-for-longer front-end rates and a term premium that the fiscal situation keeps elevated.