Markets May Be Pricing a Bank of England Response That Never Comes

Today's UK inflation landed exactly on the consensus: 3.0% in the year to February, unchanged from January. No drama in the headline. But underneath the surface, this was a mixed report — and the real story is not the number itself. It is the growing gulf between what the bond market expects the Bank of England to do and what most economists think will actually happen. That gap may be creating one of the more interesting risk-reward set-ups in UK equities right now.

Standard inflation, or headline CPI, includes everything households buy. Core inflation strips out the more volatile categories — energy, food, alcohol and tobacco — to give a better read on underlying price pressure. In February, headline CPI stayed at 3.0%, bang on expectations. CPIH, the broader measure including owner-occupiers' housing costs, also held steady at 3.2%. That leaves inflation above the Bank's 2% target, but still at its lowest headline level since March 2025. (Office for National Statistics, Consumer price inflation bulletin, February 2026)

The detail, though, was not a clean "inflation is falling" story. Core CPI actually ticked up to 3.2% from 3.1%. But services inflation — which the Bank watches especially closely as a gauge of domestic price persistence — eased to 4.3% from 4.4%, its lowest since March 2022. Clothing was the biggest upward driver in the month, while motor fuels were the biggest downward offset. Food inflation eased to 3.3%, and alcohol prices were softer because of discounting. (ONS)

It's worth noting that the ONS confirmed all February fuel prices were collected before the outbreak of war in the Middle East on 28 February. This release tells us what inflation looked like just before the latest energy shock — not what it is about to become.

February 2026 — Key inflation measures

The MPC voted unanimously on 18 March to keep Bank Rate at 3.75%. At the same time, it warned that the Middle East conflict had lifted global energy and commodity prices and that it stood ready to act if second-round inflation effects started taking hold. Reuters reported that the Bank has shifted its near-term inflation view higher, now expecting CPI to rise towards 3.5% by mid-year rather than falling back close to target. (Bank of England, Monetary Policy Summary, March 2026; Reuters, 24 March 2026)

That leaves the Bank caught between two very different risks. On one side is the inflation problem: higher oil, higher gas, and the danger that households and businesses start assuming higher prices are here to stay. On the other side is the growth problem: weaker confidence, weaker spending, softer labour demand and a more fragile economy overall. Fresh business surveys have shown the UK economy losing momentum, with March growth slowing to its weakest pace in six months, employment still falling, and manufacturers suffering their sharpest input-cost jump since 1992.

This is where the split becomes so important. The FT reported this week that economists broadly do not expect the Bank to raise rates this year, even as markets have lurched towards a far more hawkish view. Traders were, at one stage, pricing at least four Bank of England rate rises by December. That is an enormous gap between market pricing and the economist consensus. (Financial Times, "Markets wrong on UK interest rate rises, say economists")

My own view is much closer to the economists. Yes, the Iran crisis can create a sharp, short-term lift in inflation and very likely a push higher in core inflation as energy, freight and imported cost pressures ripple through the system. But that is not the same thing as a sustained domestic inflation problem. Before this shock, the Bank itself said there had been continued disinflation in domestic prices and wages. A supply-side shock can lift prices and hurt confidence at the same time — and that combination argues for caution, not aggression.

Huw Pill has been clear that the Bank cannot ignore inflation risks, but Andrew Bailey has also warned against making firm bets on rate rises. I think they still have quite a long way to go before they would actually raise. My reading is that unless this crisis becomes materially more prolonged and pushes energy prices significantly higher again, the Bank is unlikely to move rates up from 3.75% any time soon.

For equity owners, this dynamic is potentially good news. Higher interest rates would be a clear negative for housebuilders and for consumer spending more broadly. But if the market has overreacted — and the Bank ultimately stays on hold — then some of the most depressed areas of the market may be pricing in too much bad news.

That is why I think there may be opportunity here, particularly in airlines and housebuilders. Both have been hit by macro fear and rate anxiety. If the inflation shock proves sharp but temporary, and if rates do not move higher from 3.75%, those sectors could look materially better over the long term than current valuations suggest. I'm not really seeing at this stage a compelling enough reason for the Bank to hike — and if that view proves correct, the market will have to reprice.