Bank of England holds interest rates at 3.75% amid Iran war peace prospects

The Bank of England held U.K. interest rates at 3.75% on Thursday, as policymakers continue to balance the need to address above-target inflation with lackluster economic output.

The hold, which was in-line with the expectations of economists polled by Reuters, was backed by seven of the nine monetary policy committee members in the BOE's May meeting.

BoE chief economist Huw Pill and Megan Greene, an external member of the rates-setting Monetary Policy Committee, were the two dissenting voices. Pill and Greene both cast votes to hike the BOE's "base rate" by 25 basis points to 4%.

The decision comes as higher energy costs in the wake of the Iran war have pushed inflation higher in economies across the globe, and the U.K. — a net energy importer — is particularly vulnerable to price shocks.

In a summary of its decision on Thursday, the BoE said that while prices have come down since the initial spike, the war "makes it hard to predict what is going to happen with them."

The U.K.'s own inflation rate held at a cooler-than-expected 2.8% in May, with price rises driven by rising transportation fuel costs, while data published last week showed the economy shrank by 0.1% in April.

Inflation cooled to 2.8% in April, but the drop — attributed to a change to the U.K.'s regulated energy price cap — was expected to be short-lived. The price cap is due to rise by 13% later this summer, when energy costs will hit a 2-year high.

Despite easing, the bank now expects inflation to tick higher again as energy prices carry knock-on effects to the broader economy.

"The impact on the economy and inflation will depend on how long energy prices stay raised," it said. "Monetary policy cannot affect global energy prices; our job is to make sure that higher inflation does not persist and have long-lasting effects on the economy. We are monitoring the situation very closely," it added.

Despite Washington and Tehran reaching a breakthrough in peace negotiations, markets are still betting that the Bank of England will raise rates by the end of the year, according to LSEG figures.

At its April meeting, the Bank of England's Monetary Policy Committee voted to keep its key interest rate at 3.75%.

Ahead of the meeting, LSEG data showed traders were pricing in a 96% chance of the central bank keeping its key rate unchanged.