September 21, 2023 - 1:00pm

The Bank of England has today surprised markets by announcing that it would hold interest rates at 5.25%. While a 25bps increase in interest rates was expected, the Bank appears to have held back due to data earlier this week which showed inflation coming down. This is the first time the Bank has held back on rate hikes since November 2021, and reports indicate that its Monetary Policy Committee was split on the decision. 

The ONS data from August showed that inflation slowed to 6.7% from 6.8% the previous month. While not an enormous decline, this at least signalled to the Bank that inflation might be heading in the right direction, and that they might then ease interest rate hikes.

Core inflation — that is, inflation excluding cyclical elements like food and energy — performed even better, falling from 6.4% in July to 5.9% in August. The Bank has been watching core inflation very closely, and economists know that a large component of the present inflation is the energy price shock resulting from the Russian invasion of Ukraine last year. Core inflation tells us how far the effects of this shock remain.

The main components driving the rate of inflation lower were food, accommodation and services. Looking closer, one can see something that apparently escaped the Bank’s radar, given it did not hike rates: motor fuel inflation, which has been declining since March of this year, is now going down at a much slower pace. This reflects recent increases in the global oil price driven by the powerful new alliance in the market between Russia and Saudi Arabia, who have bypassed the rest of Opec+ and seized control over energy prices.

The motor fuel component of CPI tracks the Brent oil price. In August the Brent oil price was still declining, but as of today it has increased to just under $96 a barrel, meaning it is rising year-on-year. What’s more, the Saudis and the Russians are targeting a $100-a-barrel price, which implies an annual increase of over 11% if they hit their target by next month.

While the motor oil component of CPI is the most obvious channel through which changes in the Brent oil price impact inflation, it is far from the only one. Increasing energy prices raises costs for businesses across the board. This means that, if the Russians and the Saudis hit their price target in the coming weeks, the price increase in energy will flow through the economy, likely leading to the recent decline in inflation slowing or even stopping altogether.

The Bank appears not to have raised interest rates because of the positive inflation data from August. Given the news about energy prices, though, this seems like a surprisingly short-termist move by an institution which has otherwise been very aggressive about controlling inflation. If the energy price increases lead to lingering inflation in the coming months, the dissident hawks who called for a rate hike today will consider themselves vindicated — and they will no doubt let their colleagues know it.

Philip Pilkington is a macroeconomist and investment professional, and the author of The Reformation in Economics