U.S. President Donald Trump’s midterm election losses haven’t helped the U.K. economy — yet.

The Bank of England’s nine-member Monetary Policy Committee announced on Thursday it has overwhelmingly voted to increase interest rates to 4% from 3.75%, the first time since August 2023 to combat rising prices driven by the war in Iran.

Unlike the U.S. Federal Reserve and European Central Bank, the Bank of England has been reluctant to raise rates for fear of denting the British economy.

Until now, Governor Andrew Bailey and other MPC members have preferred to wait and see whether higher energy prices spilled over more broadly.

But the Bank was forced to increase rates after U.K. inflation came in at 3.5% in September, while the economy posted better-than-expected growth figures — raising the risk prices could take off.

The MPC on Wednesday voted 8-to-1 to raise rates, arguing the energy shock since the war began has built “sufficient” inflation pressures to justify a hike.

The dissenting vote from Catherine Mann was for a larger increase of 0.5 percentage points.

But Bailey made no secret of the fact that the future health of the U.K.’s economy depends on what the U.S. does in Iran.

“Today’s increase shouldn’t be seen as the first in an inevitable long sequence of hikes,” Bailey said.

“But, unless the conflict in the Middle East is resolved, neither does it seem likely to be the last increase.”

The Bank projected inflation would pick up to nearly 5% by the second quarter of 2027, higher than its previous forecast, with greater spillover into wages and other prices.

Under an adverse scenario, in which prices stay higher for longer and the conflict in the Middle East continues to flare, inflation would hit 6.2% in the third quarter of 2027.

Thursday’s decision, which comes a week after Chancellor John Healey delivered his first budget under the specter of Brits paying the highest energy prices in three years, will further squeeze struggling U.K. households and businesses already hit with higher energy bills and mortgage rates.

The tougher financing backdrop could hurt the Burnham government’s promises to tackle the cost of living. Yet rampant inflation would also undercut that pledge.

Still, the Bank’s top brass also pushed back on market expectations that rates could by hiked to 4.75% or 5% in 2027 — which could help bring down decades-high government borrowing costs.

The Trump factor

The decision comes as the rout of Trump’s Republican Party at the U.S. midterm elections on Tuesday raised the prospect of a peace deal in the Middle East.

A thaw in the conflict could bring down fuel prices by easing pressure on oil supplies and improve the cost-of-living picture for U.K. households.

There were reports Trump could respond to his party’s losses by embarking on a bombing campaign in the Middle East, but the U.S. president appeared to accept on Wednesday that higher petrol prices affected his popularity and struck a more conciliatory tone on the prospect of peace negotiations. 

U.S. Vice-President JD Vance blamed the Iran war for the electoral losses. And U.K. Prime Minister Andy Burnham said Wednesday that the elections create an opportunity to focus on the cost of living.

Oil prices fell sharply on Wednesday, amid expectations Democrats could also limit Trump’s funding for the conflict. The possibility of a ceasefire could yet be subject to Trump’s whims.

Regardless, U.K. consumers will feel the pinch through a rise in the energy price cap in January. 

Even if falling oil prices persist over the next few weeks, the price cap is likely to rise substantially because of a lag in the way it is calculated. 

The Bank forecast the cap will hit £2,150 in the first quarter of 2027. Food price increases, which have so far been muted, could hit 4.75% by mid-2027 as companies pass through higher costs.

Healey’s budget will knock 0.25 percentage points off inflation by the second quarter of next year, the Bank said, while tighter fiscal policy to bring down the deficit would likely detract from growth in the medium term.

Christine Lagarde said she will step down as president of the European Central Bank on Feb. 7, creating a vacancy at the top of one of Europe’s most powerful institutions and fueling further speculation about a possible return to French politics.

An official familiar with Lagarde’s thinking, granted anonymity to discuss a sensitive matter, said she made her move now, almost a full year before the end of her term, to have “greater freedom to express her views and to engage in non-monetary matters, because she cannot remain neutral when she sees the developments taking place in her own country and in the world.”

The ECB said in a statement only that Lagarde had informed European Council President António Costa of the decision earlier on Thursday.

The announcement clears the way for a package deal among EU capitals over at least three appointments to the ECB’s six-strong Executive Board. Isabel Schnabel, head of the Bank’s markets department, is due to leave in January to take a senior role at the International Monetary Fund, while Philip Lane is due to depart the influential chief economist’s position in May.

Negotiations over the appointments are likely to be intense, given the ECB’s vital influence in international markets, and the never-ending pressure on European government finances. Former Dutch central bank chief Klaas Knot and Spain’s Pablo Hernández de Cos, who heads the Bank for International Settlements, are seen as the two frontrunners in the race for the top job.  German Chancellor Friedrich Merz said a decision would be taken by year-end.

The timing of the announcement means that President Emmanuel Macron will have a say in choosing Lagarde’s successor before he himself leaves office next spring. Marine Le Pen, the National Rally leader and a longtime critic of the EU, is currently well ahead in the polls to win the French presidency, and may take a radically different view about who should lead the ECB. 

“The EU is trying to guard at least somewhat against the risk that right-wing Marine Le Pen may win the French presidential election,” said Berenberg Bank’s head of research Holger Schmieding. 

Jean-Luc Mélenchon, leader of the hard-left France Unbowed party, protested that Macron had already engineered a similar situation at the Bank of France, where François Villeroy de Galhau’s early departure “allowed Macron to install his assistant,” Emmanuel Moulin, as governor.

Speculation has long swirled that Lagarde, formerly finance minister under President Nicolas Sarkozy, may throw herself back into French politics. She has stressed the need for “a pro-European voice” in the French elections, while still being consistently coy about running herself. Thursday’s announcement comes at a time when candidates from mainstream camps in France are all losing ground to Mélenchon, who wants the ECB to “set fire” to its French debt holdings. None looks likely to make the final round of the presidential election in May.

Whoever follows her as ECB president will inherit an increasingly tense situation in Europe’s bond markets, where borrowing costs are hitting their highest level in years due to a cocktail of war-fueled inflation, demographics and competition from capital from Big Tech companies chasing AI-related riches. 

The problems are particularly acute in France, the eurozone’s second-largest economy, which faces a political impasse and mounting pressure over its public debt.  

Lagarde succeeded Mario Draghi at the ECB in 2019, after leading the International Monetary Fund and, in her time in office, has been a stalwart of the centrist mainstream that is now being squeezed by both wings of the political spectrum across Europe. 

“Christine Lagarde has led the European Central Bank through difficult times,” German finance minister Lars Klingbeil said in a statement.  “Under her leadership, the ECB has kept the euro stable even during crises: when the coronavirus pandemic hit Europe hard, when Russia invaded Ukraine, and most recently in the face of the economic shocks caused by the war in Iran.”

“Christine Lagarde’s tenure at the helm of the ECB has only strengthened the confidence in the European single currency,” Eurogroup President Kyriakos Pierrakakis said in a statement, promising to give the council a “swift” recommendation on the succession to heads of government.

The ECB gave no  details about Lagarde’s plans after leaving Frankfurt. However, she has talked to the World Economic Forum about taking over as chair, according to its founder Klaus Schwab. Reuters reported that the organizer of Davos could announce her appointment as early as this month.  

“I leave this institution with a sense of good work done, and an ECB that is fit for the future,” Lagarde said in a video post on LinkedIn.

This story has been updated. Giorgio Leali contributed reporting.