Bank of England governor Andrew Bailey holds a news conference – watch live

Situation in the Middle East remains volatile and as a result so do global energy prices. Oil prices in the five months since the conflict began have on average been almost 50% higher than in the months before it and higher global energy prices will push up on inflation over the coming months. Set against that the underlying disinflation of the UK economy has continued. Economic activity is subdued and the labor market is soft. There is little as yet to suggest that higher energy prices are becoming embedded in broad-based inflationary pressures in the UK economy, although we cannot draw too much comfort from that at this stage. Today, we've kept bank rate at 3.75%. Monetary conditions have tightened for households and businesses since the conflict began. We see that for example in higher mortgage rates and that tightening reflects the underlying economics in particular the expected increase in inflation from higher energy prices which needs to be considered alongside whether the underlying disinflation in the domestic economy will continue. We will monitor the situation carefully and stand ready to adjust our stance as the evidence and our judgments on the outlook evolve. It is our job to ensure that inflation gets back to the 2% target and stays there and that is what we will do.

So I will now set out the outlook for inflation in further detail before turning to the projections and scenarios that have informed the monetary policy committee's decision today. Chart one although we seem to have chart two in front of us at the moment. Well, chart one, when it appears, I hope it will, shows how the near-term outlook for inflation has shifted in recent months as events in the Middle East have evolved. 12 month CPI inflation has fallen by 0.7 percentage points since March to 2.6% in the latest data for June. That is 0.4 percentage points. Oh, here's chart one. Lower than we expected in April's monetary policy report. Inflation has been lower across a wide range of goods and services, not least food. The underlying disinflation process has been offset by higher energy prices following the conflict in the Middle East. Motorfuel prices are currently contributing 0.6 percentage points. In our latest near-term projection, that's a dashed blue line, higher energy prices push inflation up to a little above 3% by the end of the year. Energy prices remain highly volatile. However, the analysis in today's monetary policy report is based on an average of energy futures prices over the 15 working days up to the 20th of July. And that's shown here in chart two.

Over this period, front month Brent crude oil futures prices averaged $78 per barrel, which is below the $100 average ahead of the April report, but above the $64 average in the run-up to the February report. Within those 15 working days, the prices ranged from close to $70 a barrel while a ceasefire was in place to close to $90 a barrel after it had ended. And in the few days since the cutoff date for our projections, the Brent oil price has spiked to above $100 before falling back to around $84 earlier this week. As of this morning, it had gone back above $90. So these, of course, are all significant moves. And I would add a further word of caution. So-called crack spreads, the difference between the prices of refined petroleum products and Brent crude oil, have risen well above their pre-con levels, reflecting a fall in global refining output. And along with gas prices is the prices of these refined products rather than the price of crude oil that matter for domestic inflationary pressures. As chart three shows, crack spreads have fallen from recent peaks for jet fuel and diesel but continued to rise for petrol.

Given this volatility, the size and duration of the energy price shock is a key uncertainty for the outlook for UK inflation. A second key uncertainty is how the shock will transmit through the UK economy. We can already see the direct effect on the forecourts and we expect Ofgem's price cap on household utility bills to rise further to around £1,680 in the fourth quarter of this year. Though that is about 45 pounds lower than it would have been without the temporary cut to value added tax on electricity bills announced by the government last week. Over the coming months, we also expect to see the effects on consumer prices from businesses passing some of the higher energy costs they are now facing through the supply chain. Model evidence and intelligence from the bank's agents both suggest that they will build more slowly than we expected in April. But we think these indirect effects will add nearly half a percentage point to inflation over the second half of the year.

We have to watch very carefully that these direct and indirect effects do not lead to more persistent inflation from second round effects on domestic wage and price setting. Repeated inflationary episodes over the past five years have made households and businesses more attentive to inflation. Internet searches for inflation terms have spiked following the outbreak of conflict in the Gulf, for example, and remain well above historical norms, as shown in chart 4. And while they have fallen notably from recent peaks, inflation expectations remain elevated. Reassuringly, there are a few signs so far that second round effects are generating more broad-based inflationary pressures. I'll make three observations about this. First, the process of underlying disinflation in the UK economy has continued. We can see this in chart five. It shows how services inflation fell from 4.5% in March to 3.6% in June. And now underlying services inflation measures have fallen to below 4%. Although still somewhat above estimates of target consistent levels, these falls point to a broader slowing in domestic inflationary pressures. The second observation is that the backdrop of relatively weak household demand reduces the ability of firms to pass through cost increases to consumer prices. As chart six here shows, underlying GDP growth is projected to weaken slightly further in the near term as the effects of the conflict weigh further on demand. Contacts of the bank's agents point to weak demand limiting pass through of cost increases to prices. Consistent with this, two-thirds of firms in the bank's decision maker panel are expecting higher energy to result in reduced margins. And firms do not seem to expect to raise prices more than the increase in their costs. The third observation I'll make is that spare capacity in the labor market is likely to reduce workers' ability to secure higher nominal wage growth in response to higher inflation. As chart 7 shows, private sector regular wage growth eased to 2.9% in 3 months to May and we expect it to remain around that level throughout the current quarter. Other measures of pay growth remain higher at around 4% but have fallen gradually over recent months. The bank's agents continue to report average pay settlements of 3.5% for 2026 below the average settlement of 4.0% last year, citing looser labor market conditions. In the three months to July, firms in the decision maker panel expected average wage growth of 3.4% to 4% one year ahead, a little below expectations before the conflict.

But a lack of evidence so far does not rule out that wage and price setting could generate second round effects in the future, especially if energy prices remain elevated. As firms tend to make wage settlements by the second quarter of the year, for example, the impact on wage growth may only emerge well into next year. So while it is reassuring that indicators of second round effects remain benign, the overall assessment is necessarily at this stage tentative and given the uncertainty, monetary policy needs to balance the costs of leaning too little against potential inflationary pressures and the cost of responding too much. How much policy needs to lean against inflation and the level of bank rate needed to achieve that will depend on how the outlook evolves. To inform its policy deliberations and explore the outlook, the MPC has considered a central projection and two scenarios. These projections are neither all-encompassing nor do they reflect the full distribution of risks, but they reflect key sources of continued uncertainty around the future paths of global energy prices and the strength of second round effects.

Chart 8 shows the assumed paths for oil and gas prices in each of these projections. The central projection is conditioned on wholesale energy prices evolving in line with gas and oil futures curves in the 15 working days to the 20th of July. Oil prices peak at just above $100 per barrel before gradually declining to around $71. Gas prices peak at a little over 120 pence before gradually declining to a little under 60 pence. Second round effects are assumed to be moderate. In the milder scenario, energy prices follow a lower path calibrated to follow futures curves around the beginning of July, shortly after a ceasefire was announced. There are no new second round effects in this scenario. It represents a version of the future where a ceasefire agreement is fully implemented and energy price volatility is lower. In the adverse scenario, by contrast, the conflict continues perhaps in an episodic manner and with no clear resolution so that energy prices rise materially above the path in the central projection and remain above it while inflation expectations drift higher leading to stronger second round effects. Chart nine here shows the paths for inflation and the output gap in the three projections conditional on the market curve for interest rates based on an average of forward interest rates in the 15 working days to the 20th of July. In a central projection, inflation is projected to fall from its near-term peak over next year as the effects of higher energy prices fade and be slightly under the 2% target in the medium-term as energy prices fall back and the direct effects of energy prices turn negative. In the milder scenario, the path for inflation is lower throughout while inflation rises significantly and persistently in the adverse scenario.

These paths illustrate that if the assumptions underlying any particular projection or scenario come to pass, the appropriate stance of policy would likely vary from the market path on which they're conditioned. If the conflict in the Middle East persists for an extended period, for example, and we begin to see signs of emerging second round effects, it's likely that we will have to tighten policy to counter inflationary pressures in the UK economy. Similarly, if the conflict is credibly resolved in the coming months, the past would point to a looser policy stance implied by the market curve. But we do not know how the future will play out or indeed if it will play out in a way that resembles any of these projections and scenarios. And that's because the situation in the Middle East is highly uncertain. We have to set policy now seeing through the day-to-day volatility and weighing all the risks and uncertainties we face. Current market pricing for future interest rates similarly places weight on and averages across a range of outcomes for energy prices and second round effects. As chart 10 shows, model-based estimates suggest that the upward slope in the market curve reflects risk premium rather than expectations of future levels of bank rate. Similarly, median expectations in the bank's market participant survey are for bank rate to remain unchanged over the year ahead before declining further out. There's no contradiction in this. Market participants find it most likely that bank rate will remain at its current level throughout this year. While investors quite reasonably require a premium to compensate for the risk that bank rate may have to go up should inflationary pressure from the energy shock prove more persistent. That seems a reasonable position for now. The resulting upward slope in the interest rate curve has directly tightened monetary conditions for businesses and households including through higher mortgage rates. When it comes to bank rate, the MPC will set monetary policy as appropriate given the evolution of the economy, balancing all the risks to the outlook for inflation in order to achieve the 2% target sustainably. And it's in that light that a majority of the MPC voted to hold bank rate today at 3.75%. So with that, Dave Cla and I will be happy to take your questions. Thank you.

Well, I'm not going to comment on the situation in the US. That's obviously for the Federal Reserve and for Kevin Walsh. What I would say is this and it really repeats what I just said. I think that the situation we see with the market curve is entirely consistent with our reading of the economy. So you know when you say the market's doing the work I think actually it's a reflection of the economy. The market is reflecting that our views I think are consistent with that. It is consistent with a central view in the market that rates will stay unchanged this year but there is a distribution of risk which puts it on the upside and one way of illustrating is that these three scenarios that we've got and particularly the central one, I would caution somewhat that the world is so uncertain at the moment that the probabilities you would attach to those scenarios and particularly the central one is lower than usual but if you look at the distribution of those scenarios you can see a similar pattern: the upside scenario is further from the central scenario than the downside scenarios and I think that's a reasonable illustration of the economics.

So, I'm sure Clare wants to come on this. Let me kick off briefly. I mean the world feels particularly obviously the situation in the Gulf and the Middle East feels as uncertain and volatile today as it did then. I think it's the right... you can see if you compare our upside scenario today to the scenario C that we had back in April, you'll see it has a different profile. It's got a lower peak but it's persistent and I think that reflects my thinking such as it is about how this conflict plays out in a sense that we're faced... I do think there are points of resistance in this process if I'm talking broad geopolitical terms now that set in when oil prices have gone high, particularly well above when they get above 100. But as we've seen and I highlighted in the describing in the window, the normal window that we've had both the ceasefire period and the breakdown of the ceasefire period. So the way I look at the upside scenario today, it's a more persistent... missiles get fired period. We don't know what ends it because we don't properly understand really what's going on there at the moment. So that's my evolution of my thinking there. Now the last thing I'd say coming back to what I said earlier is however I do think that we've seen more evidence that indicates that the disinflation process is in place. You know CPI is under today, the latest number is under where we thought it would be back in April. That's obviously encouraging but the big question there is is this going to carry forward to the period when the second round effects from the energy price come through. But Clare, did you want to?

Well, you see, I think firstly, it's interesting when you sort of the current level of the conflict because, you know, you even look at the last week. We had a period last week where it looked like there was some settlement and some reduction in activity and then it's come back again. So I think when we talk about the current level, that's obviously a slightly hazardous comment so there is huge uncertainty there and as you rightly say that is very important. Just to reiterate, I think there are two lenses if you like here: one is that and the other is then how it's reflected through into the UK economy. And this picture I think I described where yeah we are seeing the disinflation process continue as I described. There's quite a lot of evidence coming our way that, for instance, margins are taking more of the cost pressure. But there's an awful lot of distance to travel on that story and we need to see how it evolves.

Well, the first thing to say is that the information we've received in this round on the likely increase in food prices through the rest of this year would indicate that it'll be lower than we thought it would be. And that's a mixture of information we get from our agents, information we get from surveys, and obviously that's encouraging. So let's start there as it were. Now you're right to say that there are quite a few risks around it. I think you probably named most of them but I'll say a little bit more. So first obviously there is the effect of the pass through of energy prices themselves. I think one of the things that I was struck by four years ago was just the size of the energy content in processed food cost. It is probably larger than many people, I'll put my hand up here, would predict it to be if you were asked to guess it without knowing the answer to the question. So that's obviously highly relevant. Then as you said, we don't for a moment pretend to be experts on this subject but we can observe the reporting that there is a buildup of what looks to be a large El Nino system in the Pacific Ocean off the coast of Latin America. And we know from past experience that that does have effects on the world climate to come. So we'll have to watch that one very carefully. I won't put it more than that at this stage because it's obviously uncertain and it's not our area of expertise. So yeah, there are a number of issues at play here in terms of risks.

Well, I'll do the second bit and then I think Clare will come in on your first question. I think if you look at the gilt markets, you look at government bond markets generally, I think over recent months by far the biggest influence on volatility in gilt markets has been the fluctuating events in the Middle East. There's no question that that's the biggest and dominant cause of fluctuations. We've obviously followed it very closely and you can see it in real time.

Well, you've got their paragraphs. One of the things that we've obviously changed in recent times is to introduce these individual paragraphs. So you can see their views set out there. If I can speak for them for a moment, I think you'll see a difference of view in terms of concerns about the second round effects. You can put different weightings on these scenarios as we said Clare just said it again quite rightly. Frankly, we are all of us less sure about the weightings to put on these scenarios because of the volatility in the Gulf particularly than we would normally be when we have scenarios in front of us. So that's very fair. And then I think to speak for my colleagues, I think there are some differences of view around whether given all of that and given the distribution of risks, whether it's better to act sooner or to see how this evolves. And that's reasonable, reasonable people can disagree, that's a sort of monetary strategy point really. I think we are in a position where we can sensibly wait to see how this evolves. But I absolutely respect colleagues who take a different view on that.

My only on that is I think to develop your point that second round effects emerge over quite a long period of time, because obviously that's consistent with the transmission mechanism of monetary policy that we've explained, you've written quite a lot about and spoken quite a lot about. So I think look, I'd only go so far as to say that I don't think it would be wise to wait for all of the second round effects to emerge because, in most situations if not all, it would be too late by that stage. But that doesn't help with the underlying question you're asking, which is yes, so at what point would you therefore act? Although to say you wouldn't wait till the end, I think we just have to judge that by the situation we're in. Okay.

Well, I can tell you one thing with absolute certainty. There'll be a decision in September as there always is, and we will announce it, and it'll be transparent. And as we always say, we've laid them out again: there are the principles that we operate under, and market conditions obviously form an important part of that judgment. So we will behave as we always do in that respect.

Well, the interest rate on reserves is a key anchor for the monetary transmission process, because when we announce a decision like the decision we announced today on bank rates, you can well ask, well, what does that mean? It means exactly that. It's the rate we charge on the reserves accounts that the banks have to hold at the Bank of England, and then that transmits out into the economy. So our absolute focus is that we need that rate to be aligned with the decision of the MPC to make that transmission process work. So that's a slightly longer way of saying no, that's not an issue that we've reflected on.

Right. I'll take the first part. Dave may want to say something on the second part of your question. Well, all of us as central banks obviously set monetary policy for our own domestic economy and our own domestic inflation situation. Now the UK is an open economy, so obviously we look at world conditions, and of course never more so at the moment given what's going on in the wider world, particularly the conflict in the Gulf. So the world economy enters that way. But ultimately, we all set the level of our official interest rate to match the situation in our domestic economy. So we don't say what have the Fed done or what have the ECB done and what shall we do, but we are looking at the state of the world economy, the state of the economy of our trading partners, and feeding that back through into the assessment system we have. Dave, do you want to...