The Bank of England has hinted at further interest rate cuts, which could come as soon as August.

It decided to keep rates at 4.25% on Thursday with inflation, the rate prices rise at over time, remaining at its highest level for more than a year and above the Bank’s target rate.

Governor Andrew Bailey said interest rates “remain on a gradual downward path”, but warned: “The world is highly unpredictable.”

There are concerns that the conflict between Israel and Iran, a major oil producer, could send energy costs higher and drive overall prices up, which would impact further rate decisions.

The Bank said it was “sensitive” to events in the Middle East and the impact on oil prices, which could have knock-on effects for the UK economy.

It noted that since its last meeting in May, oil prices had risen by 26% while gas prices grew by 11%.

The bank marginally lifted its expectations for the UK economy but it said that underlying growth was “weak”.

UK growth has been uneven so far this year, with the economy expanding strongly at the start of the 2025, before shrinking sharply in April.

There has been evidence that the pace of wage growth – which contributes to the rate of inflation – is slowing. At the same time, the UK’s unemployment rate has risen and businesses are holding off on recruiting or replacing staff.

“In the UK we are seeing signs of softening in the labour market. We will be looking carefully at the extent to which those signs feed through to consumer price inflation,” said Mr Bailey.

The Bank’s base interest rate dictates the rates set by High Street banks and lenders.

The higher level in recent years has meant people are paying more to borrow money for things like mortgages and credit cards, but savers have also received better returns.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, said the chances of two interest rate cuts this year were “still on the horizon”.

In every direction, there’s a conundrum to confront, so policymakers have judged that pressing the pause button on rates is the best option for now.

“Hopes for a summer rate reduction haven’t completely faded, with bets ramping up that a cut in August could provide the rays of relief that borrowers have been waiting for,” she added.

Businesses appeared to be trimming wages for some workers to pay for the rise in employment costs that came into force in April.

Employers have been hit with a rise in the amount of National Insurance they are required to pay as well as increases to the minimum wage. The Bank estimated the policy changes by Chancellor Rachel Reeves have hiked wage bills by 10%.

In the its survey of businesses, it said that pressure had grown on firms to recover the higher costs by raising prices but added “success is mixed”.

Instead it said companies were using a range of measures to cut costs, including reducing pay rises for those workers just above the minimum wage level.

Inflation remains above the Bank target of 2% at 3.4% in the year to May, and is expected to climb to 3.5% later this year. But it is expected fall back to around 2.1% next year.

Interest rates are the Bank’s main tool in try to maintain the annual rate of inflation at, or close to its target.

The theory behind increasing interest rates to tackle inflation is that by making borrowing more expensive, more people will cut back on spending and that leads to demand for goods falling and price rises easing.

But it is a balancing act as high interest rates can harm the economy as businesses hold off on investing in production and jobs.