16 June 2026: Rate to remain on hold after peace deal

If the deal between the U.S. and Iran endures and oil starts flowing again, UK inflation will likely remain below 4%, enabling the Bank of England to avoid a rate hike this summer. A 7-2 vote in favour of ’no change’ this Thursday is the most likely outcome.

A rate hike at this Thursday’s MPC meeting had already been highly unlikely given the majority of the MPC's stance. The US-Iran deal has nudged the pendulum back towards a prolonged pause. Markets now price in just a 25% chance of a July hike and only one rate increase this year, down from a peak of three.

The Bank is somewhere between doing nothing and hiking once, and 4% inflation is an important line in the sand. The Bank argued last summer that when it exceeds that level, inflation is more likely to become embedded and second-round effects more likely to materialise.

The UK economy unexpectedly contracted in April, ending a run of monthly expansions as geopolitical tensions and rising energy costs weighed heavily on output.

According to the latest figures from the Office for National Statistics (ONS), monthly real GDP fell by 0.1% in April, marking a disappointing start to the second quarter.

This marks the first monthly decline since August 2025, in contrast to the growth recorded in February and March.

The decline was driven by a 0.2% drop in services, partially offset by a 0.1% increase in construction, while production was unchanged. April’s data reinforces the view that underlying growth remains sluggish, consistent with forecasts of less than 1% expansion this year, and aligns with recent business surveys pointing to weakening activity and softer demand.

The drag on services was particularly acute in arts, entertainment and recreation, which contracted by 4.3%, as concerns grew that rising inflation would lead to a rate hike, adding to mortgage costs and eventually rental expenses.

The Bank’s Governor, Andrew Bailey, has defended the Bank's decision to reduce its holdings of Gilts, saying the move would restore its capacity to intervene in the future if needed.

Writing in The Sunday Times, Bailey said the BoE's past purchases of government debt, or quantitative easing, had been crucial in supporting the economy during the global financial crisis and the COVID-19 pandemic. With those crises past, he said it was appropriate to reverse the policy.

"Many of those who now criticise QE were not saying as much at the time," he wrote.

The Bank of England is now reducing its stock of gilts through quantitative tightening. Bailey said the overall cost of the Bank's QE and QT operations is broadly neutral.

Reform UK leader Nigel Farage and Bailey have previously had disagreements centred on the Bank's handling of bond sales and the lack of businesspeople on its rate-setting Monetary Policy Committee.

In his essay, Bailey pushed back against criticism that selling bonds locks in losses, arguing that whether gilts are sold or held to maturity does not change the overall financial impact.

"Monetary policy and financial stability are important for the people of the UK, and it is important that we have the tools to do it right," he wrote.

The pound initially reacted positively to the news of a peace deal between the U.S. and Iran, but it gave back most of its gains later in the day as investors became concerned that there is still some way to go before the deal is ratified.

Sterling reached a high of 1.3460 and closed at 1.3413.

The U.S. economy has sent mixed signals for much of the past year. Inflation data has fluctuated between encouraging and concerning, prompting new Fed Chair Kevin Warsh to question the metrics used.

Consumer spending had been surprisingly resilient until recently. Employment growth has slowed but hasn’t stalled. Yet beneath those headline numbers, some of the economy’s early-warning indicators are starting to flash caution.

One of the latest came from the Federal Reserve Bank of New York’s Empire State Manufacturing Survey. The June report delivered a result few economists saw coming: the headline index collapsed from 19.6 in May to just 5.7 in June. Even worse, economists had expected a reading of 30.1, although it appears their market research is sadly lacking.

Although the index remains positive, indicating that manufacturing activity is still expanding, the speed of the decline suggests conditions deteriorated far faster than anticipated.

The Empire State Manufacturing Survey is one of the earliest monthly snapshots of U.S. manufacturing activity. Released by the Federal Reserve Bank of New York, it surveys manufacturers across New York State on business conditions, including new orders, shipments, employment, inventories, and pricing.

Because it is released before many other manufacturing reports, investors often treat it as a proxy for broader trends across the U.S. industrial economy. It isn’t a perfect predictor, but it offers an early indication of whether manufacturers are seeing stronger demand or pulling back.

That matters because manufacturing tends to be cyclical. Changes in factory activity often appear before shifts in hiring, capital spending, and economic growth.

U.S. consumer resilience can persist through the rest of the year. Still, it is becoming increasingly uneven and fragile as energy prices remain high, labour markets soften, and household buffers erode.

Higher-income households continue to spend; lower-income households are already cutting back as the economy becomes more K-shaped.

Fitch noted that household net worth rose 3.5% YoY in 2025, driven by strong equity markets, helping sustain spending into 2026. While larger tax refunds have cushioned the energy-price shock, these buffers may be exhausted by September.

CEOs across industry, manufacturing, and finance have been sharing their views on the economic outlook for the rest of 2026 and into next year.

They typically see resilience today, slowing momentum ahead, and heightened uncertainty driven by geopolitics, energy prices, and a cooling labour market.

Across sectors, CEOs describe the U.S. economy as still growing, but at a slower, more uneven pace and highly sensitive to energy prices and global conflict. The country depends on high-income consumer spending, but faces tighter credit conditions as banks pull back.

The economy should enter 2027 with weaker tailwinds than in the past two years. While many executives say the U.S. is not in a recession, the risk is rising.

The dollar index fell yesterday amid a rise in risk appetite, as the likely outcome of the war in Iran has been decided, even though it is likely to leave the Strait of Hormuz unchanged from before 28th February. The index initially fell to a low of 99.38 but recovered, closing at 99.28 as nascent dollar buyers returned.

ECB President Christine Lagarde welcomed news of a U.S.-Iran ceasefire, saying it could help reopen the Strait of Hormuz. Still, some of her colleagues cautioned that it would not immediately bring down high inflation in the euro zone.

Bundesbank President Joachim Nagel told reporters, “Fortunately, a ceasefire and the reopening of the Strait of Hormuz are now in sight. There is reason to hope for peace,” he said in a speech in Frankfurt. “Nevertheless, even if the Strait becomes navigable again soon, it will take months for the oil supply to return to normal.”

U.S. and Iranian officials said overnight they had reached a preliminary agreement to end their war and reopen the Strait, a gateway for energy shipments, in a deal that sent oil prices lower and curbed bets on ECB rate hikes.

"If this news is confirmed by developments in the coming days and the signing of a memorandum of understanding, it is good news. We can only welcome it," Lagarde told French radio. She cautioned, however, that "the whole question of uranium enrichment remains to be debated, agreed and concluded in the form of an agreement".

Last week, the ECB raised interest rates for the first time in nearly three years to try to curb inflation before the surge in energy costs that has followed the unprecedented supply disruption linked to the Iran war spreads further across the euro zone economy.

This will now be seen as a cautionary move, and markets will expect to hear fewer hawkish remarks from members of the ECB’s Governing Council as a prelude to the start of rate cuts, although they are unlikely to happen before 2027.

This could all come to nothing if the memorandum of understanding does not morph into a solid peace treaty acceptable to both sides.

Eurozone industrial output rose slightly by 0.1% in April 2026, marking a modest gain after stronger growth in March.

There was strength in non-durable consumer goods, which rose by 1.7%, and durable consumer goods rose by 1.0%. Intermediate goods rose by 0.8% across the entire region.

However, the energy sector fell by 0.4% and capital goods by 0.5%.

This mix shows that consumer-oriented production rebounded, while energy and capital goods remained soft, reflecting ongoing cost pressures and cautious investment.

Meanwhile, the Eurozone’s trade balance swung sharply into deficit in April 2026, driven by surging energy imports and a narrowing surplus in machinery and vehicles. This marks a significant reversal from last year’s strong surplus.

The energy deficit widened significantly as the bloc paid more for imported fossil fuels amid elevated global prices. At the same time, the region’s traditionally strong machinery and vehicles surplus shrank, contributing materially to the swing into deficit.

Imports grew at nearly twice the pace of exports (9.3% vs 5%), outweighing export gains.

The single currency extended its rally to 1.1620 but ran into strong selling pressure, driving it back close to where it had opened. It closed marginally higher at 1.1590.

Have a great day!