City economists are challenging the market consensus that the Bank of England will push UK interest rates up by a full percentage point or more by next summer. Current market-implied expectations suggest the Bank may implement at least four rate increases over the coming year, lifting the current 3.75% bank rate to 4.75% by late July and potentially hitting 5% with a fifth hike by December 2027. But if oil prices keep increasing in the meantime, they would face mark-to-market losses and potentially margin calls, an investor could be right that interest rates won’t rise as far as markets think. “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,” Raja said. “It’s not to say it won’t happen. Which currently point to the bank rate peaking between 4.75% and 5%,” they told clients last week, this is significantly below the peak in money market expectations.
However, many analysts argue such an aggressive tightening cycle is unlikely, particularly as there is minimal evidence that rising energy costs are fueling a broad inflationary spiral across other sectors. James Smith, a developed markets economist at ING, noted that while the swaps market currently prices in four hikes with no subsequent cuts, he finds little consensus for that outlook among industry professionals. According to and I think you’d be hard-pressed to find anybody that really agrees with that,”, James Smith, a developed markets economist at the Dutch bank ING. “Once we strip that out, we have estimated that there is only really ~50bps [half a percentage point] of hikes pencilled in,” he said.
Smith expects the Bank to potentially sound an “all clear” by next spring and believes rate cuts could be on the table by the end of next year. He explained that traders remain cautious and reluctant to bet against the current trend due to significant uncertainty surrounding energy supplies and winter inflation levels. Many traders previously incurred losses earlier in the Middle East crisis when they incorrectly positioned themselves for earlier rate cuts. According to “It can get pretty painful, so a lot of traders are quite reluctant to take this risk until there’s greater certainty about energy supply and the extent of inflation this winter,”, Smith. He has calculated that a lot of the forecast interest rate rises is actually “baked-in risk premia” – where investors require an extra return to protect them from uncertainty or instability.
Sanjay Raja, chief UK economist at Deutsche Bank, also questioned the necessity of the market’s aggressive outlook.
While acknowledging that a 5% peak is not impossible, he stated that no mainstream forecaster currently supports such a high trajectory based on existing data.
Raja suggests much of the current pricing reflects “baked-in risk premia”—a premium investors demand to hedge against volatility—rather than actual expectations for policy tightening. Stripping away these premiums, Deutsche Bank estimates only about 50 basis points of further hikes are likely, with their base case seeing rates settle at 4.25% by February and remaining there through 2027. One is that these expectations have been closely correlated with oil prices since the Iran war began.
The Bank of England is widely anticipated to increase rates to 4% at its meeting on November 5, following September’s inflation reading of 3.5%. Other major institutions are echoing the skepticism toward more aggressive hikes. Goldman Sachs has stated its probability-weighted forecasts remain notably below current market pricing, even while expecting a move to 4% next month.
Similarly, Oxford Economics projects the rate-raising cycle will be far less severe than market indices imply, forecasting only two 25-basis-point increases in November and February to reach 4.25%. Morgan Stanley maintains a similar outlook, though they noted potential upside pressure could emerge if the Low Pay Commission recommends a national living wage hike larger than current projections.
Even within the central bank, signals suggest market sentiment may be overshooting. Bank of England chief economist Huw Pill expressed skepticism during an IMF meeting in Bangkok this month regarding the necessity of four additional rate hikes over the next year, reinforcing the view that the current market-implied peak of 4.75% to 5% may be too high.
