UK Inflation Nears 2% Target Amid Political Risks

The UK is on track to hit its 2% inflation target ahead of schedule, according to Bank of England Governor Andrew Bailey, but the positive economic news is shadowed by growing political uncertainty.

In a conversation with CNBC, Bailey confirmed that the Monetary Policy Committee (MPC) expects inflation to reach the bank's target by spring, sooner than previously anticipated. However, he stressed that the key challenge is ensuring it stays there.

"The critical thing now, though, is, of course, that it stays there," Bailey said.

BoE Holds Rates Steady Amid Internal Division

The governor's comments followed the central bank's decision to leave interest rates unchanged at 3.75%. While the move was widely expected, it revealed a sharp 5-4 split within the nine-member MPC.

According to Bailey, the division reflects a core debate over how to manage inflation sustainably. While falling energy prices are providing downward pressure, some committee members remain concerned about persistent inflation lingering from past economic shocks. This debate over the right policy level to lock in the 2% target was "the focus" of the meeting.

"I'm encouraged by what we are seeing, but I do want to see some more evidence," Bailey added, highlighting the need for progress in areas like services inflation and wage setting to ensure the target is met "sustainably."

Analysts interpreted the close 5-4 vote as a signal of a more dovish stance. Thomas Pugh, chief economist at RSM U.K., predicts the next interest rate cut could come as early as April, when inflation is projected to be under 3% and wage growth has cooled further. He also suggested another cut could be on the table in the second half of the year.

Political Storm Clouds Gather Over UK Markets

Thursday's rate decision coincided with renewed uncertainty surrounding the leadership of Prime Minister Keir Starmer, creating a new layer of risk for UK assets.

Market analysts are closely watching the political developments. Dominic Bunning, head of G10 FX strategy at Nomura, pointed out that increased pressure on Starmer poses a risk to the UK's fiscal trajectory. He noted that during past political challenges, sterling and long-end gilt yields have shown a negative correlation.

Bunning argued that there are few, if any, potential successors to Starmer who would be considered more market-friendly, as his political bias is "firmly towards the centre rather than the left of the party." A change in leadership would likely mean a new finance minister, "creating the risk of negative fiscal sentiment returning."

Pugh of RSM U.K. echoed these concerns, stating that a potential leadership challenge is now the biggest risk to gilt yields. "The odds of Kier Starmer not being Prime Minister by the end of the year have jumped from around 50% yesterday to over 60% today," he noted.

Global Economy Shows Resilience, But Uncertainty Remains

When asked about the UK's political situation, Bailey declined to comment on specific matters but acknowledged that the central bank is carefully monitoring a "heightened level" of global uncertainty.

He observed that the world economy has proven more resilient than anticipated over the last year.

"The world economy has been more robust, frankly, looking back, than we thought it would be a year ago, looking forwards," Bailey said.

However, he cautioned that this does not guarantee a smooth path ahead. "That doesn't mean that therefore it follows naturally that we will just sort of sail through all of this uncertainty around the world unaffected," he concluded, reaffirming that the BoE will continue to watch developments closely.