15 May 2026: Pill calls for a ‘prompt but modest’ rate hike to quell inflation pressure

The UK economy surprisingly grew by 0.6% in the first quarter of 2026. However, economists have refused to become too excited about the data, believing that in March, as the conflict in Iran began, consumers front-loaded “big ticket” items as they became more concerned about inflation “down the road” as oil prices spiked.

Industrial Production also grew slightly, while construction returned to growth, which was only partly a reversal of weakness at the end of last year.

There were indications that Q1 data could be positive following a revised 0.4% expansion in February, but the war in Iran is expected to weigh on macroeconomic data going forward. The economy grew 0.3% in March, the ONS said on Thursday.

The U.K., a net energy importer, has already seen consumer prices rise during the war, largely driven by rocketing fuel costs.

The Bank of England, which has said that the severity of the hit to the British economy will depend on how long the war lasts, is expected to hike interest rates later this year.

The National Institute of Economic and Social Research commented that while the first-quarter GDP data reflected a “relatively strong outturn”, it largely reflects old news.

Although growth held up in March, there are signs of underlying weakness in the wake of conflict in the Middle East. Business confidence has taken a hit, input price inflation has risen, and job vacancies are falling.

Economic uncertainty in the U.K. has fueled calls for Prime Minister Keir Starmer to step down over the past week, following the ruling Labour Party’s dismal performance in local elections.

While Starmer has vowed to remain in office for now, he remains vulnerable to leadership challenges, with a cohort of over 90 Labour lawmakers calling for his resignation, and three possible contenders believed to be preparing to challenge him.

The real test for the economy will come as the standoff in the Strait of Hormuz continues and oil prices remain above $100.

The Bank of England is at the forefront among G7 central banks, which have taken a hawkish view of the rise in inflation.

Chief Economist Huw Pill said yesterday that a "prompt but modest" increase in interest rates would help head off the risk of inflationary pressure from the war in Iran becoming entrenched in the British economy.

Pill, who cast the lone vote for an increase in borrowing costs at the BoE's last rate-setting meeting, said policymakers needed to consider whether rates should rise sooner rather than later.

"If you wait until the market is forcing you to move, I think that may involve more challenges for the Bank than if you act a little more actively," he said at an event hosted by NatWest.

By taking "prompt but modest" action, the BoE would be able to influence the response of businesses and workers to the rise in headline inflation, Pill said.

Earlier, BoE Deputy Governor Sarah Breeden was quoted by the Financial Times as having an alternative view, saying that interest rates did not need to rise in June or July, while BoE Governor Andrew Bailey has acknowledged Pill's argument but said he wants more time to assess the situation.

Pill said the risk of so-called second-round effects, such as firms raising prices or workers demanding higher pay in response to an energy-driven rise in inflation, was likely to be weaker than it was after Russia's full-scale invasion of Ukraine in 2022, given the current weakness in the labour market.

The Health Minister resigned from the Cabinet yesterday, making a considered, rather than scathing, review of the Prime Minister's performance since he came to power.

Wes Streeting, along with former Deputy Prime Minister Angela Rayner and Mayor of Manchester Andy Burnham, are all expected to “throw their hats in the ring” once a leadership challenge is announced.

Burnham was prevented from standing in the Gorton and Denton by-election in February, but Starmer has said that he will not be blocked from standing in a future by-election.

The pound reacted poorly to the mixed signals it received yesterday as concerns over the impact of a change of leadership in the Labour Party took a toll. It fell to a low of 1.3396 and closed at 1.3403.

The International Monetary Fund has said it welcomes the initial positive dialogue between U.S. President Donald Trump and Chinese President Xi Jinping, adding that reducing tension and uncertainty between the world's two largest economies is good for the world.

"It's very important, of course, that the world's two largest economies are engaging at the highest level," IMF spokesperson Julie Kozack told a news briefing when asked about the Trump-Xi summit's initial outcomes in Beijing.

"We certainly welcome the fact that there's a constructive dialogue between the two countries. Anything that helps reduce trade tensions and uncertainty is good for both large economies, and, of course, good for the global economy as well," she added.

Pressures from the war in the Middle East and Iran's closure of the Strait of Hormuz, which has kept crude oil prices above $100 per barrel, mean that the global economy is clearly moving toward the middle of the three economic scenarios outlined in the IMF's April World Economic Outlook.

The IMF's middle "adverse scenario" would see global real GDP growth fall to 2.5% this year, compared with 3.1% in the more benign "reference forecast" that assumes a quick end to the conflict.

The more adverse scenario assumes $100-per-barrel oil for the full year, along with tighter financial conditions and rising inflation expectations.

Kozack said that although higher energy prices have raised expectations of short-term price increases, the IMF views medium-term inflationary expectations as remaining well-anchored. Financial conditions in the global economy remain "accommodative," she said.

Strong U.S. retail sales are reinforcing concerns that inflationary pressures could remain elevated as consumers continue to spend despite rising costs linked to the war in Iran. Markets are also weighing the possibility that higher inflation expectations could push Treasury yields even higher.

President of the Federal Reserve Bank of Kansas City, Jeffrey Schmid, has said that continued inflation is the most pressing risk to the economy. During a speech at a banking industry conference, he stated that the US economy is less vulnerable to global oil market disruptions than in the past. Still, high oil prices drain household spending power and raise business costs.

He went on to say that continued inflation is the most pressing risk to the economy, as it is still too high, even as the US economy has shown remarkable resilience and economic fundamentals remain sound.

The economy is less vulnerable to global oil disruptions than in the past, but high oil prices drain household spending power and raise business costs. However, the job market is functioning effectively. Consumer spending remains the biggest driver of activity, and wealth gains are leading many households to increase spending.

Business investment remains strong, especially in tech and AI buildout, and conditions are fundamentally sound in the banking sector.”

Stephen Miran is stepping down as a Federal Reserve governor, paving the way for Kevin Warsh to become the new Fed chair. Miran's term had already expired, but he will resign when Warsh is sworn in. Warsh's appointment aligns with President Trump's push for lower interest rates to boost the economy.

Miran often pushed for larger rate cuts than most at the Fed. He criticised how inflation data is measured, especially aspects such as A.I. spending and portfolio fees, which he says could misinform decisions and hurt jobs.

With Warsh stepping in at a tricky economic moment, all eyes are on how he'll steer US monetary policy next.

The dollar index rose yesterday, encouraged by the news that the Trump/Xi summit was a success. It reached a high of 98.91 and closed at 98.88

While the US-Iran war and the closure of the Strait of Hormuz have pushed headline inflation higher and dampened economic activity, Governing Council Member Madis Muller remains cautiously optimistic about the underlying economic foundation, stating that the economy hasn't fallen into stagflation.

This contrasts with recent Eurozone GDP, which showed modest 0.1% growth in Q1, with a more pronounced slowdown likely in the second quarter. Moreover, PMIs have indicated a clearer slowdown in economic activity in recent months, alongside strong price pressures.

Muller has emphasised that the ECB will require a "fast resolution" to the disruptions in the Strait of Hormuz to avoid hiking in June. Without an official reopening and lower oil prices, Muller warned that a June rate hike is likely.

The ECB President, Christine Lagarde, has recently highlighted a state of "double uncertainty," noting that the Central Bank is grappling with both the duration of the energy shock and its potential second-round effects on wages and consumer prices. Unlike the 2022 inflationary spike, when the ECB was criticised for acting too late, officials now feel they have a better grasp of the transmission risks.

Several Governing Council Members have suggested that at least two interest rate hikes may be necessary this year if the war continues and Brent crude prices do not retreat. For now, the ECB has held the deposit rate steady at 2%, relying on the "advance effect" of rising market interest rates to do some of the tightening work.

However, as Muller noted in prior comments, this effect loses its potency if the Central Bank holds for too long while price pressures mount.

Another Governing Council member, Olli Rehn, has warned that data are beginning to point to stagflation resulting from the war in Iran and rising energy prices.

“The first signs were already visible in the statistics, when growth in the euro area in the first quarter was only slightly positive, and inflation accelerated to 3 percent,” the Finnish central-bank chief said in a speech earlier this week.

While stressing that the current shock is “not quite as big” as the last spike in prices in 2022, he said events have shifted away from the ECB’s baseline outlook and closer to a “less favourable scenario, at least for oil prices.”

“Today we’re once again seeing an external price shock related to geopolitical tension and the volatility of energy markets,” Bulgarian Central Bank Governor Dimitar Radev said separately in Sofia.

Rehn, like his colleagues, stressed that the key factors are the war's strength and duration, as well as potential spillovers. But he said there’s no sign yet of inflation expectations de-anchoring and called developments over wages “reassuring.”

Eurozone services activity contracted in April for the first time in almost a year, as weakening demand and deteriorating export business weighed on consumer-facing sectors amid the war in the Middle East, a recent survey showed.

The Euro suffered as the dollar rallied yesterday. It fell to a low of 1.1665 and closed at 1.1669.

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