Where next for interest rates?

The Bank of England kept interest rates on hold at 3.75% in July following an easing of inflation in June - but financial markets are predicting borrowing costs may soon be on the rise again.

The Monetary Policy Committee (MPC) voted 6-3 to keep rates on hold on Thursday. The decision was expected - headline Consumer Price Index (CPI) inflation has been edging lower and was confirmed as rising by 2.6% annually in June. That is ahead of the Bank’s 2% target but slightly below expectations. The Bank raises rates to combat higher inflation.

Inflation is expected to rise again, however, with renewed fighting in the Middle East pushing oil and future energy prices higher. 

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Prices in the bond market reflect where investors believe rates are headed in the future. Prior to the latest rates decision, markets had been predicting the next movement in rates to be upwards, with a quarter-point rise most likely to arrive at the 5 November MPC meeting. A further rise is then possible next Spring. Any rise beyond that looks uncertain, according to current market levels.

That represents a slight softening of expectations - as many as three quarter-point rises were being predicted earlier this month.

The Bank must decide how much higher energy prices caused by the Middle East conflict are likely to become embedded. A spike in energy prices will push the headline level of inflation higher, but the Bank may not raise rates in response if it believes the rise is temporary - higher UK borrowing costs cannot bring down global energy prices.

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The Bank will be wary, however, that higher energy prices can cause a wider inflationary spiral if they result into higher wages to meet those higher prices. This is what happened following Russia’s invasion of Ukraine.

Much depends, then, on the labour market - and here the backdrop is generally supportive of lower rates. Unemployment stuck at 4.9% in the three months to May, slightly ahead of the same period as before, while wage growth slowed in the same period to 3.4% for regular earnings (excluding bonuses) and 4.3% for total earnings (including bonuses). This extra ‘slack’ in the labour market makes it arguably less likely that high energy prices will translate into higher ingrained inflation.

• Read: What do rate cuts mean for markets?

Elsewhere in the world, the US Federal Reserve kept rates on hold at its latest rate-setting meeting, held a day before the Bank of England’s decision.

The next UK interest rate decision is scheduled for 17 September 2026 followed by MPC meetings on:

• 5 November 2026
• 17 December 2026
• 4 February 2027

How rates have changed

The path ahead for interest rates, as implied by market prices, has changed significantly following the outbreak of the conflict in the Middle East. 

The chart below shows the implied level of interest rates from 16 February 2026, just before the conflict broke out, then more recent readings on 22 July and 28 July 2026. This is based on market prices for government bonds with different lengths of maturity.

You can see how the path for rates on 16 February - prior to the outbreak of fighting - was downwards. Expectations rose significantly after fighting broke out. The reading for 22 July shows that expectations rose to price in as many as three quarter-point rate rises over the year. Those expectations have moderated slightly over the past week and the most likely course - based on 28 July market prices - is for just two more rises.

As such, rates are expected to peak at 4.25% next year, although a further rise is possible. Please note that these prices are indicative and will change daily.

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