As expected, the Bank of England’s (“BoE”) Monetary Policy Committee (“MPC”) voted to raise interest rates to 4% last week. The MPC unanimously supported a rate hike, with eight members voting for a 25bp increase and one member preferring a 50bp hike.
Forward guidance shifted to a more hawkish (negative) tone, signalling that the size and duration of the energy shock now requires a monetary response. Specifically, the MPC "judged that the risk of material second-round effects emerging had risen further since September and could remain a risk for some time." The majority of members leaned towards a second hike in the near future before pausing.
This leaves the door open to a further 0.25 percentage point increase at the next MPC meeting in December. However, being so close to Christmas and with consumers’ finances already stretched by elevated energy prices, there are expectations that this may be pushed back to February. This will also provide the MPC with more time to see whether the recent decline in oil prices helps to reduce short-term inflation expectations.
So, how did we get here? In short, the war in Iran. If you cast your mind back to January 2026, expectations were for the BoE to continue cutting rates, as it had done throughout 2025. Inflation was falling and a sluggish economy signalled that the disinflation process was on track.
However, this all changed in February when the US and Israel began strikes on Iran, causing oil prices to rise. Higher oil prices have pushed up inflation, particularly in the UK, where many goods are imported from abroad.
So, why is the BoE raising rates? It has two principal objectives: monetary stability (maintaining low and stable inflation, with a 2% target) and financial stability (ensuring the financial system remains resilient and functions effectively). The BoE is tackling the first objective by raising interest rates to combat inflation (currently 3.5%), which has driven up the cost of living. On the second, the BoE recognises that the UK economy is resilient and in a better place than expected, with GDP growing by 0.1% in August 2026. This suggests the economy can hopefully handle a rate rise without significantly stunting growth.
How does this work? Higher interest rates increase the cost of borrowing (credit cards, loans etc) and make it more expensive for consumers to spend. They can also increase mortgage payments, reducing disposable income, which is bad news for borrowers.
On the flip side, it’s good news for savers. Higher interest rates provide an incentive for people to save money, as they’ll receive a better rate of interest on their cash deposits.
The UK is a nation of cash savers, rather than investors, holding over £2 trillion in bank deposits. Given that the risk-free rate of return is increasing, the BoE is effectively seeking to encourage households to save rather than continue spending at the current rate. Lower spending should, in turn, bring inflation back towards the 2% target. However, this could still be some years away, with peak inflation predicted to rise to 5% by mid-2027.
While higher interest rates may improve the return available on cash, inflation can still reduce its real value. Investors holding substantial cash balances should therefore consider whether their money is earning a competitive rate, whether it remains accessible when required and whether it is sufficiently diversified. A professionally managed cash portfolio can help balance these priorities, while allowing cash to play a deliberate role within a wider investment strategy.
