As UK inflation approaches 4% and the Iran war shows no sign of ending, a Bank of England rate hike on Thursday is almost universally regarded as a done deal. But how many more hikes the Bank of England will deliver afterward has produced a clear split between economists and investors.
In the first scenario, after completing its first rate increase since 2023 this week, the Bank of England would raise rates three more times before the end of next summer. Resilient UK economic growth, a stabilizing labor market, and an energy shock that has worsened further in recent weeks are forcing the Monetary Policy Committee to lift the bank rate to at least 4.75% — an outcome that has been priced by money markets since early September.
The other scenario — also the consensus among economists — points to a hike to 4% this week, followed by only a 50% probability of another increase in the first quarter of 2027. Supporting this view are signs that consumers are beginning to rein in spending and little evidence so far that the energy shock is triggering a price feedback loop. If policymakers push back against prolonged tightening, UK government bonds could rally, especially short-dated issues whose yields have already hit three-year highs. Another possibility is that the Bank of England leaves investors waiting for clearer signals on future rates, since current market pricing is helping it fight inflation by pushing up household and corporate borrowing costs.
Market Pricing and Economist Forecasts Diverge Sharply
"Everyone has been expecting energy prices to fall back and has been setting inflation and bank rate forecasts accordingly," said Paul Dales, chief UK economist at Capital Economics. "That is why economists generally don't think there will be too many rate hikes and expect rates to come back down. But we are now in an environment where, if energy prices stay around current levels for another six months or so, rates will likely be higher."
Strategists at Bank of America noted a 0.55 percentage point gap between market pricing and the bank's economists' forecast for the bank rate, one of the largest divergences among major economies. The Bank of England has said that investors demanding compensation for rising risks to the rate outlook partly explains the aggressiveness of the market curve. But even one of the Bank of England's most hawkish policymakers, chief economist Huw Pill, warned that he is "skeptical" about the need for four rate hikes. Rate strategists at Bank of America and Citigroup attributed the gap to risks that energy prices continue to rise, the Iran war shows no sign of ending, and the UK economy keeps outperforming expectations. August GDP unexpectedly grew for a third straight month, signaling third-quarter expansion well above the Bank of England's July projection of 0.1%. Elias Haddad, global market strategy head at Brown Brothers Harriman, said this makes the Bank of England's communication around market pricing, and its corresponding forecasts for inflation and the UK economy, "key to assessing the room for hikes after this week." Bank of America strategists including Mark Capleton said that if the Bank of England pushes back against "excessive" market pricing, the UK curve could see a "bull steepening," in which short-end bond yields fall more than long-end yields.
A Decision That Avoids Surprises
After UK Chancellor John Healey's first budget was largely digested by the market last week, the Bank of England may also want this decision to avoid surprises. Because markets expect multiple rate hikes, financial conditions have tightened, allowing the Bank of England to hold steady and leaving it behind the Federal Reserve and the European Central Bank in policy action. Yet policymakers know that expectations ultimately need action to support or recalibrate them. Bank of England Governor Andrew Bailey poured cold water on market bets in the spring, when traders priced as many as four rate hikes. Bailey and Deputy Governor Sarah Breeden both pointed to signs that companies are cutting costs to cope with the energy shock rather than passing on price increases to consumers. And that was even before the Bank of England last week published a surprisingly dovish private-sector survey. With consumers under pressure, many businesses are finding it hard to raise prices, and so far few surveyed executives plan to raise wages next year in response to the inflation shock, suggesting second-round effects remain limited for now.
"The Monetary Policy Committee will likely push back mildly against market pricing," said Dani Stoilova, an economist at BNP Paribas. Policymakers "may use tighter UK financial conditions and limited evidence of second-round effects to justify a less aggressive path."
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