Bank of England expected to raise interest rates amid energy price shocks

The Bank of England is widely expected to raise interest rates by 25 basis points to 4% at its meeting on 5 November. This follows UK inflation rising above its target to 3.5% in September.

Market Expectations vs. Economist Forecasts

Financial markets have priced in significant tightening, with some expectations suggesting rates could reach 4.75% by the end of July or even 5% by December 2027. However, several economists argue these market-implied rates are too high.

• ING: James Smith, a developed markets economist at ING, stated, “If you look at the swaps market, and you look at what’s priced in for the Bank of England, you’ve got four rate hikes and then no cuts ever. And I think you’d be hard-pressed to find anybody that really agrees with that.” Smith suggested the Bank could be "sounding the all clear" by next spring.
• Deutsche Bank: Sanjay Raja, chief UK economist at Deutsche Bank, said, “I do not believe that any mainstream forecaster thinks the Bank of England will hike to 5% by the end of next year with the information set we have today.” He estimated that once "baked-in risk premia" are removed, there is only approximately 50 basis points of hikes pencilled in.
• Oxford Economics: This consultancy forecasts the Bank will raise rates at its November and February meetings to reach 4.25%, which they noted is "significantly below the peak in money market expectations."
• Goldman Sachs: The firm stated its probability-weighted forecast path remains "notably below market pricing."

Drivers of Interest Rate Policy

Analysts suggest that rising energy prices are a primary driver for potential rate hikes. A spike in natural gas prices has led to expectations that headline CPI will peak slightly above 4% early next year.

ING analysts expect a follow-up rate hike in February, noting that the Bank is likely to hike "for insurance purposes" due to the risks presented by energy prices. While some officials, such as Sarah Breeden, have noted that many businesses are absorbing energy shocks rather than raising prices, the Bank's July research suggested that second-round effects become more likely once inflation surpasses 4%.

Impact on the Pound

Sterling has seen recent support from the view that high energy prices leave the Bank of England with little choice but to hike rates. Additionally, factors such as UK fiscal policy and warmer ties with the EU are contributing to the currency's performance.

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Sources

• think.ing.com: Bank of England set for first rate hike as energy shock worsens | ING THINK
• theguardian.com: Interest rates unlikely to reach 4.75% by next summer, say City economists | Interest rates | The Guardian

This article was drafted with AI assistance and checked against the sources above. Company claims are reported as claims. Cover image is AI-generated.