The Bank of England has kept interest rates unchanged at 3.75%, with exchange rate considerations playing a subtle but important role in policy decisions. Sterling’s value affects inflation through import prices and competitiveness through export demand.
The monetary policy committee’s 5-4 vote incorporated awareness that rate decisions influence the pound’s value. Cutting rates typically weakens currency by reducing returns to foreign investors, while holding rates supports it. The committee must balance these exchange rate effects against domestic considerations.
A weaker pound raises import prices, contributing to inflation, which would complicate the Bank’s goal of returning to 2% by spring. However, it also makes UK exports more competitive, supporting growth and employment. With GDP forecast at just 0.9% and unemployment rising to 5.3%, some sterling weakness to boost exports might be welcome.
Conversely, maintaining rates at 3.75% while other central banks cut could strengthen sterling, reducing import price inflation and helping achieve the 2% target. However, this would hurt exporters and could deepen the growth slowdown. The committee must judge which exchange rate channel is more important currently.
Governor Andrew Bailey’s projection that inflation will fall to around 2% by spring incorporates some assumption about sterling’s path. If the pound strengthens significantly, import prices could fall faster, accelerating the return to target. If it weakens substantially, import inflation could offset the impact of domestic factors and government measures. Chancellor Rachel Reeves’s budget measures, including utility bill cuts and rail fare freezes from April, work through domestic channels independent of exchange rates. The forecast showing inflation at 2.1% by mid-2026 assumes sterling remains reasonably stable without extreme movements either way.
Bank of England Maintains 3.75% Rate as Exchange Rate Implications Influence Policy Calculus
