"Stagflation" clouds the Bank of England: no suspense, internal hawk-dove signals are key in standing still on Thursday

On Thursday, the Monetary Policy Committee (MPC) of the Bank of England will announce its latest interest rate decision. It is widely expected that the benchmark interest rate will remain unchanged at 3.75%, but with April unexpectedly seeing a cooling of inflation facing a strong backlash from soaring energy bills, the UK economy recording its first contraction in eight months in April, the labor market continuing to cool, and a hawk-dove showdown within the central bank evolving into its most divisive since the outbreak of the Middle East conflict. Governor Bailey insists that "policy has already tightened", Chief Economist Pill has advocated for a rate hike for two consecutive months, and another hawkish member Greene has called for a swift tightening of monetary policy. At least two members of the nine-member committee are ready to hit the rate hike button, with several research institutions predicting that this week's voting pattern will expand from the previous 8-1 to 7-2. Rising energy prices are driving cost-push inflation, economic contraction After a brief slowdown in inflation, it may return to an upward trajectory, with household bills expected to rise by around 13% in the middle of the year. The trend of UK inflation is experiencing a temporary and misleading breather. Data from the UK Office for National Statistics shows that in the 12 months to April 2026, the Consumer Price Index (CPI) fell significantly from 3.3% in March to 2.8%, while the core CPI also dropped from 3.9% to around 2.5%. The main driver of the unexpected drop in inflation in April was the fall in household energy bills triggered by the lowering of the price cap by the UK energy regulator Ofgem, but this base effect is widely seen in the industry as one-off and unsustainable. Real alarm bells began to ring from midsummer. The Confederation of British Industry (CBI) warned in its outlook report released on June 9 that the continued transmission of soaring energy prices caused by the Middle East conflict to the supply chain would push UK inflation to around 4% by the end of this year. Economist from Credit Suisse further calculated that with the expected 13.5% increase in Ofgem's price cap taking effect in July, combined with the seasonal rise in summer airfares, inflation could peak at an annual rate of 3.8% in November. The median forecast of 65 economists is for inflation to peak at 3.6% this year, averaging 3.3% for the entire year of 2026, gradually falling to 2.6% by 2027. A notable signal comes from the long-term inflation expectations survey released by the Bank of England on Friday, which rose to 4.0%, reaching the highest level since at least 2009. This sharp rise reflects the market's real concern about the risk of inflation "unanchoring". However, the monthly household inflation expectation survey conducted by Citigroup/YouGov has fallen for two consecutive months since hitting a three-year high in March, partly easing the Bank's vigilance against rapid public inflation expectations. Unexpected GDP contraction in April, services sector sees first contraction in five years Signals from the growth side are even chillier. Data released by the UK Office for National Statistics on June 12 showed that GDP shrank by 0.1% month-on-month in April, the first monthly contraction in eight months. While GDP in the first quarter still recorded 0.3% positive growth, the services and manufacturing sectors had already shown clear signs of cooling demand pressures in the early second quarter. The services PMI dropped from 52.7 in May to 49.3 in June, slipping into contraction territory below the 50 mark for the first time since April 2025. Tim Moore, Director of Global Market Research at Standard & Poor's, said weak domestic and foreign market demand was the main drag, with hotels and transport sectors particularly affected by sharp rises in input costs. Indicators for the labor market also point in the same direction. In the first quarter of 2026, the unemployment rate in the UK rose from the previous period's 4.9% to 5%, with the number of unemployed reaching 1.806 million, an increase of 192,000 year-on-year. More forward-looking indicators show that job vacancies in the recruitment market between February and April 2026 fell to their lowest level in five years, with a net decrease of 28,000 vacancies compared to the previous three months. The Office for National Statistics' payroll data is even more direct - in April, the monthly wage bill decreased by 100,000 people, far weaker than the market's expectation of around 28,000, with March seeing a similar decline of 28,000. Wage growth data at the enterprise and union level has also narrowed. In the first quarter of 2026, employee wages excluding bonuses increased by 3.4% year-on-year, rising by 4.1% including bonuses - after factoring in inflation, real wage increases are very limited. Neil Carberry, CEO of the Confederation of British Industry, pointed out that the current wage growth rate has begun to fall, indicating that external price shocks are unlikely to trigger a sharp rise in domestic wages. Bailey insists on a wait-and-see approach, hawkish camp brewing for expansion At the policy-making level of the Bank of England, a tug-of-war over "when to take action" has moved from behind the scenes to the forefront. Governor Bailey has repeatedly defended a strategy of "standing still" in various public forums. A key argument he has repeatedly emphasized is that the Bank of England's policy stance has essentially already "tightened proactively" - ceasing rate cuts since April itself constitutes a de facto policy tightening. He pointed out at a central bankers' meeting in Reykjavik, "Compared to market expectations, we have significantly tightened our policy response to shocks, and this has already had an impact on the economy." Economist Hetal Mehta of St. James's Place also supported this assessment, stating that "momentum in the labor market has significantly cooled, and there is currently no momentum to support a rate hike." However, a faction led by Chief Economist Huw Pill is rising. Pill warned publicly in mid-May that the Iranian energy shock poses significant price pressures on the UK economy, and uncertainty should not be an excuse for inaction. He called for a "moderate but swift" rate hike. "We don't want to rush to make very quick decisions when assessing the situation, but we also can't let inflation dynamics slide out of control," Pill said in a discussion at NatWest. He is concerned that the second-round effects of inflation may be stronger than expected by most members, suggesting that the transmission mechanism between the Iranian shock and food costs is more direct than during the Russia-Ukraine conflict period, with food costs being a key variable affecting inflation expectations. Another key figure, Megan Greene, is poised to move from being a "hawkish observer" to an actual actor this week. In a speech in early June, Greene made it clear that "as the conflict continues, the case for a rate hike is strengthening," and suggested that it may be necessary to tighten monetary policy in the coming weeks or months. Her core logic is that the speed and extent of policy responses are equally important, and the risk of inaction may be more severe than the risk of action, even though the duration of the wartime energy shock is limited, taking preventive rate hikes is a more prudent choice. Greene also emphasized that the second-round effects of inflation may fall somewhere between the 2011 surge in energy prices and the 2022 Russia-Ukraine natural gas crisis, with the risk of businesses passing on higher costs to consumers being greater than the risk of workers demanding wage increases. A recent statement by Catherine Mann also indicated that a rate hike may be possible at some point if the energy crisis worsens. The minutes of the April meeting showed that four other members, including Greene, clearly stated - if the energy shock further escalates - they would support a rate hike at future meetings. Based on the evolving statements of these officials, several institutions have updated their predictions for the June meeting. Morgan Stanley expects the voting pattern this time to be 7-2, with Greene joining Pill's rate hike camp, while the other seven members support maintaining the status quo; Deutsche Bank's chief UK economist Sanjay Raja also predicts a 7-2 voting outcome. UBS also expects Greene to support a rate hike, but at the same time points out that the committee will "resist betting on further rate hikes." It should be noted that since the June meeting does not come with a Quarterly Monetary Policy Report (MPR), the members will not be able to update their economic forecasts simultaneously, meaning that any changes in the voting pattern will carry more weight in terms of policy signals. Looking ahead: the signal game behind Thursday's decision The outcome of the June 18 meeting itself is no longer in question, but the signals released by the meeting will be crucial. Cost-push inflation rising in tandem with the structural features of a weak economy forms the core basis for the Bank of England to "stay unchanged in the face of changing circumstances": since a rate hike cannot directly lower energy prices, the main effect of a rate hike will focus on further suppressing the already fragile economic growth; conversely, maintaining the current rate and observing the evolution of energy prices may actually be the option with the least losses. This logic is reflected in a survey of 65 economists - around 40% of respondents expect at least one rate hike by the end of the year, but only six expect a rate cut during the year, and Fitch Ratings has placed the Bank of England alongside the Federal Reserve in the camp of "maintaining rates unchanged this year and resuming rate cuts in 2027". Three key signals deserve special attention: firstly, whether the voting pattern officially evolves into 7-2. Based on current public statements, Pill and Greene are likely to vote for a rate hike, and if the voting record indeed shows that two members are calling for an immediate rate hike, it will be the clearest "hawkish escalation" signal from the Bank of England since the Middle East conflict. Secondly, whether there are any changes in the wording of the post-meeting statement regarding the trend of energy prices. If the statement emphasizes "the increasing risk of a second round of energy shock effects", it indicates that more members are inclined to an early rate hike; if the wording remains "continuing to assess the data", then Bailey's wait-and-see approach will still dominate. Thirdly, the flexibility of Governor Bailey's words at the press conference. Whether he starts to leave room for future rate hike paths will directly affect the market's pricing for rate hikes before the end of the year. Looking further ahead, the rate path of the Bank of England will largely depend on the trajectory of oil prices and the extent of market expectations for the diffusion of secondary inflation effects. As warned by Sanjay Raja of Deutsche Bank, "the duration of the energy shock is becoming increasingly significant, and the spillover effects of price pressures are becoming alarming". If a peace agreement between the US and Iran is truly reached and the passage through the Strait of Hormuz is restored sustainably, the peak of inflation could be significantly lowered, reducing the pressure on the Bank of England to hike rates this year. Conversely, if geopolitical tensions intensify again or the progress of energy facility repairs lags, the pressure for inflation to rebound to the 3.5% to 4% range in the third quarter of this year will force the Monetary Policy Committee to make a difficult choice between "economic slowdown" and "inflation out of control".