Traders Price Three BOE Hikes Next Year as Inflation Risks Mount

(Bloomberg) --

Traders are pricing in as many as three Bank of England interest-rate hikes next year, betting policy makers will be more concerned about a surge in inflation than an uncertain economic recovery.

Money markets penciled in around 65 basis points of tightening by the BOE’s December 2022 meeting on Thursday, according to sterling overnight index swaps, which would take the key rate to 0.75% from 0.1% currently. The move pared to around 64 basis points as of 4:20 p.m. in London.

The wagers come after officials surprised investors last week by leaving the door open for a potential rate hike as soon as November, and as inflation accelerated to the strongest pace in more than nine years in August. 

“Inflationary pressures remain the main driver of monetary policies,” said Althea Spinozzi, a fixed-income strategist at Saxo Bank A/S. “If energy prices continue to surge they may force the central bank’s hand into hiking already by the end of this year.”

The BOE expects inflation will climb to more than double its 2% target by the end of the year, largely driven by rising energy prices. Still, policy makers may be too cautious to pursue an aggressive tightening cycle, given the economy remains in a highly uncertain position.

The tightening will likely be spread out over three hikes, with an initial 15-basis-point adjustment to 0.25% priced for February followed by two additional quarter-of-a-percentage point increases in June and December 2022.

‘Too Much’

“The market often shifts U.K. money market contracts further than most people expect once momentum builds,” said Peter Schaffrik, global macro strategist at RBC Europe Limited. “We think that this is probably too much.” 

Sterling rose as much as 0.7% to $1.3517 after touching its weakest level against the dollar since December on Wednesday. Gilts led losses across major peers, with the yield on 10-year bonds rising seven basis points to 1.07%, the highest since May 2019.

Officials have flagged concerns about the labor market after the end of the government’s furlough plan, while households are also facing looming increases in their tax and energy bills that economists say could hurt confidence and reduce the opportunity for hikes.

Governor Andrew Bailey acknowledged those risks earlier this week, saying moving too soon on could disrupt the U.K.’s still nascent economic recovery.

“Tightening monetary policy could make things worse in this situation by putting more downward pressure on a weakening recovery of the economy,” he said Monday.

While the central bank traditionally shifts its key interest rate by multiples of 25 basis points, it last cut rates by 15 basis points in March 2020, at the height of the coronavirus pandemic. If officials wanted to raise rates, a move back to 0.25% is seen by strategists as the likely first step.

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