Government policy, not the Bank of England will determine future interest rate hikes

Today's inflation data showed headline inflation rising to 3.1% in August from 2.9% in July, with motor fuel prices driving the increase. Core inflation remained stable at 2.6%. The Bank of England is unlikely to raise rates tomorrow due to the soft labor market data, which showed a contraction in monthly payrolls. However, it's too early for mortgage holders to relax, as the governor may signal a low bar for rate hikes at upcoming meetings.

The looming risks come from global energy prices and the upcoming Budget. Global energy prices have surged due to tensions in the Middle East and a drone attack on key pipeline infrastructure. This has increased global oil prices by 20% and natural gas prices in the UK by over 100% since July. These rising energy costs could push UK household energy bills up by 20% to 25% in early 2027, adding around 1 percentage point to headline inflation and keeping it above 3% through 2027.

Higher global gas and electricity prices will also increase businesses' costs, potentially leading to 'second round effects' on inflation. The government's fiscal policy, particularly the upcoming Budget on October 28, is another key risk. If the government expands deficit spending without implementing structural reforms, it could increase the pressure on the Bank to raise rates.

However, major reforms to reduce the deficit and boost the supply-side of the economy could make the Bank more willing to keep rates on hold. Key reforms include reforming the 'triple lock' on pensions, abolishing the 'Manhattan Skyline' of marginal tax rates, and lifting the moratorium on new drilling for gas and oil in the UK.

These choices are for the government, not the Bank of England, but they will significantly impact domestic interest rates in response to global shocks.