The Bank of England is preparing to raise interest rates for the first time since 2023, as policymakers reassess how much borrowing costs must rise to contain persistent inflation without causing a sharper slowdown in the UK economy.

Markets expect the Monetary Policy Committee to increase Bank Rate from 3.75% to 4% at its meeting on Thursday, although investors are closely watching the accompanying guidance for clues about whether further increases are likely.

A new debate over the UK’s neutral rate

The immediate decision has prompted a broader debate inside the central bank about the level of interest rates that is neither stimulating nor restraining economic activity. Officials had spent much of the year arguing that rates were already sufficiently high to bring inflation under control, but the latest outlook has challenged that assumption.

The question matters because an incorrectly judged neutral rate could leave policymakers either applying too little pressure to inflation or unnecessarily weakening demand. The Bank must balance elevated price risks against a subdued growth environment and pressure on household finances.

Markets focus on the policy signal

Investors are expected to pay at least as much attention to the Bank’s forward guidance as to the rate decision itself. A rise to 4% is broadly anticipated, so any indication that policymakers see a prolonged tightening cycle—or conversely consider the move largely precautionary—could affect sterling, government borrowing costs and UK bank shares.

Energy prices remain a particular concern. Higher energy costs can feed into headline inflation and inflation expectations, potentially increasing the amount of restraint required from monetary policy. The Bank’s assessment of those risks will help determine whether Thursday’s move is viewed as the start of a new phase or a single adjustment.

Implications for businesses and households

Higher rates would increase financing costs for companies with floating-rate debt and could weigh on investment decisions, particularly among smaller businesses. Banks may benefit from higher lending margins, but weaker loan demand and greater pressure on borrowers could limit that advantage.

Households refinancing mortgages or carrying variable-rate borrowing would also face additional costs. The impact on consumption is likely to be a central consideration for policymakers as they assess whether inflationary pressure is broadening or beginning to fade.

The decision will therefore set the tone for UK financial markets and the wider economy well beyond Thursday. With markets already pricing a move to 4%, the most significant question is whether the Bank signals that rates have entered a higher “new normal” or that the latest increase is intended to be limited in scope.