Financial markets are betting that the Bank of England will more than double interest rates next May, as fears of inflation in the UK continue to grow.
The change in expectations in the swap market – 4% interest rate forecast in May versus 1.75% now – has been one of the biggest swings in recent years.
A change in expectations, driven by a continued increase in forecasts inflationary and soaring energy prices, which were reflected in other markets. In the UK gold-plated market, two-year government borrowing costs have risen more in the past two weeks than in any similar period since 2003.
Market moves will be reflected in corporate borrowing costs and fixed-rate mortgages, affecting companies and households even before Bank of England decision on interest rates in the coming months.
Higher borrowing costs will be a further drag on UK economic activity and the finances of households and businesses already affected by high energy, fuel and food prices. – although city economists expect interest rates to be less.
Traders in the overnight index swap market – where prices are set based on expectations of future official interest rates – are currently betting that rates will rise to 2.75% by the November meeting of the BoE before hitting 4% in May.
Separately, the yield on two-year government bonds – indicating the average yield over the next 24 months – is now trading at 2.94%, compared with 1.83% just a month ago.
Traders have grown concerned as UK inflation has mostly exceeded expectations each month this year – rising to 10.1 per cent in July – amid forecasts by some Cities that prices will rise more than 18%.
With energy prices continuing to weigh on inflation, new retail gas and electricity price ceilings for October-December will be announced on Friday. Analysts expect Ofgem, the industry regulator, to increase the annual energy cost for the average household from £1,971 to more than £3,500.
Interest rate and government bond futures market traders pushed interest rate expectations higher as inflation rose to double digits last week and as Citi forecast inflation to hit 18% for the week. this.
The financial market’s projections for interest rates reflect the BoE’s assessment that it will be prepared to act “strongly” if it feels that inflation has become a corporate and household expectation.
Economists are less willing to bet on the BoE being too aggressive with monetary tightening. The consensus among City economists is that interest rates will peak at 2.5%, but expectations are changing.
Paul Dales, chief UK economist at Capital Economics, which expects interest rates to hit 3%, said market expectations have “spiked up” over the past few weeks.
“At this stage, I really don’t want to rule anything out,” he said. “The point we are trying to make is that if our 3% rate forecast is proven wrong, then at this point it is more likely because interest rates peaked at 3.5% instead. because 2.5% – 4% isn’t completely vain anymore. “
But he added: “History shows that the market tends to overuse tightening cycles. So at the moment, my hunch is that the markets have gone a little too far.”
