By David Milliken, William Schomberg and Yoruk Bahceli
LONDON, July 30 (Reuters) - The Bank of England kept interest rates on hold on Thursday as it waits to see how the Iran war affects inflation pressures,
although the renewal of hostilities prompted a third policymaker to back a rate hike.
The Monetary Policy Committee voted 6-3 to keep rates at 3.75% rather than the 7-2 split most economists polled by Reuters had expected. Catherine Mann joined Megan Greene and Chief Economist Huw Pill in voting for a rise to 4%.
Other MPC members stuck with the wait-and-see approach of Governor Andrew Bailey, which he hopes will ensure inflation does not overshoot its 2% target by too much this year.
Bailey said expectations among investors of a rate hike later in 2026 mostly reflected the risk of a further escalation of the U.S.-Israeli war on Iran.
He also said there had been no shift in the BoE's overall thinking about the need for higher borrowing costs.
"Please do not leave this room thinking that the Bank of England is edging towards a hike, because frankly, there's nothing in what I said, and I think any of us have said, along those lines," Bailey told reporters.
Two-year gilt yields, which are sensitive to the outlook for official borrowing costs, were more than 11 basis points lower at 4.347% at 1300 GMT. Sterling edged down against the U.S. dollar.
"Despite the sharp rise in energy prices, the majority (on the MPC) appear unconvinced this will translate into more persistent domestic inflation," said George Brown, senior economist at Schroders.
NEW UK GOVERNMENT SEEKS TO LOWER COST OF LIVING
A continued stay on rates would be a relief for Britain's new Prime Minister Andy Burnham, who has prioritised cost-of-living measures, including scrapping a tax on household electricity bills. The central bank said that would help lower inflation by a tenth of a percentage point.
The BoE's new central forecast - which assumes energy prices move broadly as markets expect and that spillovers from high energy costs into pay and price-setting are limited - showed inflation rising to 3.2% later this year from a 15-month low of 2.6% in June and staying above target until early 2028, when it would dip below 2%.
That is a softer inflation outlook than in the BoE's April quarterly forecasts but similar to what it predicted in June.
However, this scenario is based on market expectations that the BoE will raise rates in the final quarter of 2026 and again in 2027, in contrast to the expectation of economists in a Reuters poll that saw no further tightening this year.
While the European Central Bank raised interest rates in June, Bailey has said the BoE can afford to stay on hold because it had cut rates by less before the outbreak of the Gulf conflict in February.
The U.S. Federal Reserve kept rates unchanged on Wednesday but three policymakers preferred a quarter-point rise. Chair Kevin Warsh said he had "no tolerance" for inflation.
WIDENING MIDDLE EAST CONFLICT CAUSED MANN TO VOTE FOR HIKE
The BoE's Mann cited a breakdown of a tentative truce between the United States and Iran and a broadening of the conflict this month as the main trigger for her change of view.
Although British inflation is, unusually, below rates in the euro zone and United States, that largely reflects how regulated household energy bills in Britain lag behind market prices.
For the MPC members who backed a rate hike, the fact that inflation has been above the BoE's 2% target for almost all of the past five years increases the chance of damaging second-round effects.
Others saw no evidence that these risks were materialising and focused more on a weaker labour market, where private-sector pay is now growing at the slowest pace since 2020.
However, Deputy Governor Clare Lombardelli said the lack of second-round effects so far was "informative but not conclusive".
Separately, the BoE raised its estimate of the impact of shrinking its government bond holdings, saying quantitative tightening (QT) had added a "modest" 0.2 to 0.3 percentage points to gilt yields since 2022, up from 0.15 to 0.25 percentage points in last year's assessment.
The MPC holds its annual vote on the pace of reducing its bond portfolio in September. The BoE slowed QT to £70 billion ($93 billion) a year in 2025 from £100 billion previously, and market participants expect a further reduction to £50 billion.
(Reporting by David Milliken, William Schomberg and Yoruk Bahceli, additional reporting by Suban Abdulla, Editing by Catherine Evans)
