By David Milliken
LONDON, June 15 (Reuters) - The Bank of England looks set to keep interest rates at 3.75% on Thursday as Governor Andrew Bailey judges the central bank can take its time to assess if higher energy prices from the Iran war will generate lasting inflation pressure.
Unlike the European Central Bank, which raised interest rates for the first time in nearly three years last week, Bailey views the BoE as effectively having done the same already by halting its previous plans to cut rates this
year.
"We have already tightened policy considerably in response to the shock relative to what had been expected by markets. And that is already affecting the economy," Bailey told fellow central bankers at a conference in Reykjavik last month.
UK ECONOMY SHRANK IN APRIL
Official data last week showed Britain's economy shrank 0.1% in April after expanding by 0.3% in the first quarter of the year, while the Confederation of British Industry predicted unemployment would hit an 11-year high of 5.5%.
Against this backdrop, the rise in inflation to just over 3.5% later this year that the Bank of England sees as possible may squeeze households and boost inflation worries but poses less risk of inciting a spiral of rising wages and prices.
"This is a kind of situation where higher inflation expectations will be harder to translate into faster wage growth, just given the kind of weakness we are seeing in the economy and the labour market," said Debapratim De, chief UK economist at Deloitte.
Financial markets on Friday - when U.S. President Donald Trump said again that a deal with Iran to halt the war was close - did not fully price in a BoE rate rise until November. Early in the conflict, as many as four rate hikes were priced in for this year.
Monthly household inflation expectations measured by YouGov for U.S. bank Citi have fallen twice since hitting a three-year high in March, although the BoE's own quarterly survey of longer-term inflation expectations on Friday rose to its highest since at least 2009 at 4.0%.
OTHER BOE OFFICIALS LIKELY TO SEEK JUNE RATE HIKE
Not all BoE policymakers are as happy as Bailey to take a wait-and-see approach.
Chief Economist Huw Pill voted for a rate rise in April - after already viewing policy as too loose before the conflict - and worried about a dysfunctional labour market where outsize wage rises can still occur despite higher unemployment.
One or two more of the Monetary Policy Committee's nine members might join Pill this month in voting for a quarter-point rate increase.
Most likely to do this is Megan Greene, who at the start of this month said a rate rise could be needed as soon as "over the next few weeks" to reassure markets and the public that the central bank is taking the inflation threat seriously.
Greene highlighted the breadth of price rises in Purchasing Managers' Index surveys of the services sector as well as typically more energy-intensive manufacturers.
"The risk of acting, even if inflation proves to be less persistent, is less severe than the risk of failing to act," she said.
British inflation has been at or below the BoE's 2% target for only a few months in the past five years - a worse track record than either the ECB or the U.S. Federal Reserve.
Post-COVID supply chain disruption was followed by Russia's full-scale invasion of Ukraine, which caused a spike in oil and gas prices. Domestic factors around regulated energy and water bills have helped keep headline inflation above target, despite some government efforts.
Henry Cook, senior economist at Japanese bank MUFG, said the BoE did not need to hike rates now but would probably need to act sooner rather than later.
"We do think there is a risk that they end up dithering a bit too much," he said. "Playing for time is potentially not the best strategy here."
(Editing by Catherine Evans)
