Financial markets are pricing in interest rate rises that City economists believe are unlikely to materialise, with the Bank of England expected to fall well short of the 4.75% level forecast by traders by the end of July next year. According to market-implied interest rate expectations, the Bank is likely to raise rates at least four times over the next year, lifting the bank rate from 3.75% to 4.75% by the end of July, and possibly to 5% by December 2027. However, a number of City experts dispute this sharp tightening cycle, pointing to the lack of evidence that rising energy costs are pushing up other prices sharply.
James Smith, a developed markets economist at ING, said traders have priced in four rate hikes with no future cuts, a scenario he believes few economists would support. He told a briefing in the City that the Bank could be signalling the all clear by spring next year and cutting rates again by the end of 2027. Sanjay Raja, chief UK economist at Deutsche Bank, said he does not believe mainstream forecasters think the Bank will hike to 5% by the end of next year given current information. He estimated that much of the forecast increases represents risk premiums rather than genuine rate rise expectations, with only half a percentage point of hikes actually pencilled in once this is removed.
Economists cite several reasons why market pricing may be inflated. Since the Iran war began, market-implied interest rate expectations have become closely correlated with oil prices, with traders reluctant to bet against further rate rises until there is greater certainty about energy supply. Many traders suffered losses earlier in the Middle East crisis when positioned for rate cuts that did not materialise, making them wary of taking contrarian positions now.
Deutsche Bank's base case is for the Bank of England to take the bank rate to 4.25% by February 2027 and then hold rates there until the end of 2027. Oxford Economics forecasts quarter-point increases at November and February meetings, taking the rate to 4.25%, significantly below the 4.75% to 5% peak in money market expectations. Even Huw Pill, the Bank's hawkish chief economist, has suggested market expectations are too high, expressing scepticism at an International Monetary Fund meeting that four rate rises over the next year will be needed.
The Bank of England is widely expected to raise interest rates to 4% at its next meeting on 5 November, after UK inflation rose to 3.5% in September. Goldman Sachs expects this November rise but maintains its probability-weighted forecast path remains notably below market pricing. Morgan Stanley's base case is for rises in November and February with rates on hold thereafter, though it notes potential pressure if the Low Pay Commission recommends a larger increase in the national living wage than expected.