Bank of England Stands Pat, Introduces Scenario Analysis Framework

The Bank of England announced on Thursday that it would maintain the base interest rate at 3.75%, in line with market expectations. Governor Bailey stated post-meeting that the current level of interest rates is "reasonable".

The biggest focus of this meeting was that the Bank of England abandoned its traditional central forecast model in favor of a scenario analysis method, presenting three economic paths around the "second-round effects" that could be triggered by tariff shocks, reflecting a clear divergence within the decision-making layer on the mechanism of inflation transmission.

Scenario A assumes no second-round effects, with inflation climbing to 3.6% by the end of 2026.

Scenario B assumes partial manifestation of second-round effects, with inflation peaking at 3.7% by the end of 2026. Under these two scenarios, it is anticipated that the UK's inflation rate could fall back to or below the target level of 2% by 2028.

The most severe Scenario C assumes a sharp increase in energy prices that remain high, with the CPI surging to 6.2% in the first quarter of 2027 and the unemployment rate rising to 5.7%. Bailey pointed out that if this scenario becomes reality, the central bank would need to "tightly tighten monetary policy" in response.

It is noteworthy that the Bank of England clearly stated that there is a possibility of interest rate hikes in all three scenarios, signaling a hawkish signal to the market.