31 July 2026: Bailey is waiting for the outcome of the conflict in Iran

Catherine Mann joined Huw Pill and Megan Greene to vote for a rate hike at yesterday’s meeting of the Bank of England’s Monetary Policy Committee.

A continued pause in rate hikes was agreed by a margin of six votes to three, as Andrew Bailey warned that UK inflation was set to rise again as the U.S.-Iran war kept energy prices elevated.

Despite the inflation outlook, the Bank opted against raising its benchmark rate at its regular policy meeting, leaving borrowing costs at 3.75% for a fifth consecutive time.

“Inflation has fallen faster than we’d expected, but the conflict in the Middle East continues to mean high and volatile energy prices,” the Bank’s Governor said after announcing the rate decision.

“That will cause inflation to rise again later this year.”

The widely expected decision came after the Federal Reserve held U.S. interest rates steady on Wednesday. Bailey joined the five remaining members in calling for no change, minutes of the meeting showed.

The committee said it stood “ready to act” to ensure inflation meets the Bank’s 2% target.

Reading between the lines, the Bank of England has a simple message for British workers losing their jobs or homeowners facing high mortgage rates: Blame Donald Trump.

Political sensitivities prevented Governor Andrew Bailey from being quite so direct, even as the Monetary Policy Committee voted to keep interest rates unchanged; however, the subtext of his comments and the Bank’s new forecasts was clear. There is no problem with domestic inflation, but there may be one if the US President continues his war with Iran.

As long as that threat persists, the BOE won’t give the UK economy a shot in the arm by cutting rates. Homeowners will have to live with higher interest costs, and jobs will be lost.

The signs are that inflation in the UK is less of a threat than feared, despite higher energy and food prices driven by the war. There has been “a broader slowing in domestic inflationary pressures,” Bailey said.

Inflation was 2.6% in June, 0.4% lower than the Bank’s forecast in April. Second-round effects that would embed those higher prices in the economy appear to be under control as firms take the hit in “reduced margins” rather than passing costs on to already squeezed consumers, Bailey added. “Underlying GDP growth is projected to weaken slightly.”

Yet the situation in the Middle East is highly uncertain, and no one knows what will happen next.

Less than two weeks into his tenure as the United Kingdom's seventh Prime Minister in a decade, Andy Burnham is already facing intense scrutiny over his macroeconomic vision and the nation's fiscal trajectory.

Burnham entered 10 Downing Street with an ambitious pledge to decentralise political power and revitalise British manufacturing.

However, prominent economic analysts and bond markets are aggressively questioning how the new administration plans to finance these sweeping reforms amid a severe structural deficit.

The central challenge dominating Burnham's early days in office stems from a stark warning issued by the Office for Budget Responsibility. Official projections indicate a looming budget deficit that will fundamentally constrain the new government's spending capacity. Economic commentators argue that relying on traditional tax-and-spend frameworks will prove insufficient to plug this gaping hole without stifling domestic economic growth.

Sterling softened modestly yesterday, with GBP generally lower against the USD and slightly weaker against the EUR, as markets digested both the Fed’s hawkish-leaning hold and the Bank of England’s rate decision. The three major G7 Central Banks that have held monetary policy meetings over the past week appear committed to lower inflation but need to see a definitive move to end hostilities in the Gulf before taking any action.

Kevin Warsh is leading markets in a “merry dance” because his new communication style at the Federal Reserve is forcing traders to react to data rather than to the Fed’s stated intentions. That shift is driving sharper, more volatile repricing across yields, FX, and risk assets as investors adapt to a regime with far less forward guidance.

Warsh’s stripped-down, no-guidance approach means markets must interpret economic data in real time, producing choppy, sometimes contradictory moves. This ‘merry dance’ is likely to continue as long as Warsh maintains his current stance.

Warsh has removed the Fed’s traditional signalling. Markets no longer know what the Fed intends, only what it says at present. Analysts can no longer hang on to the Chairman’s every word, as too few words are being spoken, leaving them to interpret the Central Bank’s intentions. Added to that, the FOMC is not complying with Warsh’s apparent intention to bring inflation under control, since it continues to vote against a hike in rates, even as three dissenters voted for a hike at this week’s meeting.

Furthermore, Warsh has not explained why he is not in favour of advance guidance and seems oblivious to the rise in volatility his methods have created.

Warsh wants to outsource monetary policy to financial markets. In his view, the Central Bank’s role is to be the referee, not to influence market expectations.

By not tightening monetary policy this week, Warsh missed an opportunity to rebuild the Fed’s credibility. This would have helped square the circle between his rhetoric, his commitment to the 2% inflation objective, and his determination to achieve that goal.

Tightening would have made it clear that Warsh was in charge and not beholden to market expectations. If the Fed tightens in September, Warsh may be viewed as having been forced to act to restore his credibility and/or to avoid appearing to have lost control of the rate-setting Committee.

Whisper it quietly, but will markets detect the hand of the President in Warsh's apparent inertia?

While Trump continues to call for lower rates, not hiking when inflation demands it provides him with a platform to continue his crusade.

U.S. GDP growth slowed unexpectedly in the second quarter, with the economy expanding at an annualised rate of 1.5%, while underlying inflation metrics remained stubbornly high, official data showed.

The advance estimate released by the U.S. Bureau of Economic Analysis for the April-June period fell well short of market expectations, which had forecast 2.1% growth. The reading also marked a noticeable deceleration from the first quarter, when GDP did increase by 2.1%.

According to the BEA, increases in consumer spending, investment and exports supported the overall economic expansion. However, these gains were partly offset by a downturn in government spending. Imports, which subtract from GDP calculations, increased by 11.5% in the second quarter, compared with 11.8% in the first quarter.

The dollar was broadly, if marginally, weaker, with the index down about 0.5% over yesterday’s session. The move reflected a reversal of Wednesday’s knee-jerk Fed reaction and a shift back to risk-on positioning.

The end of the government's fuel tax rebate pushed German headline inflation higher in July. These first tentative signs of knock-on effects will add pressure on the ECB to hike in September.

Germany's real inflation has finally revealed itself. The first estimate of July headline inflation reflects the full impact of higher energy prices, as July was the first month without the government’s fuel tax rebate.

German headline inflation increased to 2.8% YoY in July, from 2.3% YoY in June. The European inflation measure, more relevant to the European Central Bank, also came in at 2.8% YoY, from 2.4% YoY in June.

Looking at the available components, these are the first tentative signs of knock-on or indirect effects of higher energy prices on the rest of the economy. On a YoY basis, energy was the main driver, but prices for goods, transport, and healthcare also accelerated in July. On a more positive note, prices for clothing and shoes fell in July compared with June. Maybe some retailers started to sell off their World Cup merchandise after the German national team’s disappointing performance.

Despite these tentative signs of knock-on effects, the current inflation picture remains structurally different from the 2022 inflation wave. In June, around half of the main inflation components were growing at less than 2%, while just over a third recorded inflation above 3%. By contrast, in 2022, more than two-thirds of components rose by more than 3%, while only around 20% had an inflation rate of less than 2%.%.

Looking ahead, the path of headline inflation will be heavily affected by the war in the Middle East and oil prices, as in other G7 economies. The recent swings in oil prices have been another reminder that it’s almost impossible to consider oil price assumptions for any inflation forecast lasting more than a few days. In any case, knock-on effects from higher energy prices will push up transport costs, food prices, and other industrial product prices over the coming months.

Seasonally adjusted GDP rose by 0.4% in the Eurozone and by 0.5% in the wider European Union in the second quarter, compared with the previous quarter, according to a preliminary flash estimate from Eurostat.

In the first quarter, GDP was stable in the euro area and increased by 0.1%in the EU, Eurostat said in a press release.

On a YoY basis, seasonally adjusted GDP rose by 1.0% in the Eurozone and by 1.2% in the EU in the second quarter, after increases of 0.5% and 0.8%, respectively, in the previous quarter.

Among Eurozone Member States, Ireland recorded the highest quarter-on-quarter increase at 3.9%, followed by Lithuania at 1.7% and Sweden at 1.4%. Belgium and Austria were the only Eurozone members to record negative year-on-year GDP growth in Q2. Both posted 0.0% quarter-on-quarter growth, but only Belgium recorded a negative annual rate, making it the sole member with a year-on-year contraction.

The Euro strengthened yesterday, recording broad gains against the US dollar and holding firm against most major currencies as markets digested the Fed’s decision and assessed Eurozone GDP and inflation data.

Have a great day!