Traders Bet on More BOE Hikes by End-2022, Taking Key Rate to 1%
Traders are wagering the Bank of England will increase its key rate to 1% by the end of 2022, the highest in more than a decade, as inflationary pressures ramp up expectations for policy tightening.
Money markets priced around 90 basis points of tightening by the BOE’s December 2022 meeting on Wednesday, according to sterling overnight index swaps, which would take the key rate to 1%. Previously, traders only fully priced one 15-basis-point hike by end-2021 and two quarter-of-a-percentage point increases next year.
A combination of higher energy costs, supply chain disruptions and rising wages in some industries has undercut the BOE’s original view that much of the jump in prices will prove transitory. The central bank last month said it expects inflation to exceed 4% in the last quarter, more than double its target.
While rates traders are ramping up bets on tighter policy, the pound has been weighed down by concerns that any efforts to curb inflation would darken the outlook for growth and consumer sentiment.
“While the odds are high for early rate hikes, the steep pricing of the path next year has a much higher degree of uncertainty,” said Tanvir Sandhu, Chief Global Derivatives Strategist at Bloomberg Intelligence. “Pricing the bank rate to quickly return to 1% by the end of next year looks excessive in relation to risks to the economy.”
BOE Inflates Rates Volatility, But Risk/Reward Has Now Shifted
Over the weekend, BOE Governor Andrew Bailey and policy maker Michael Saunders moved to reinforce signals for an imminent rise in interest rates. That has prompted traders to expect at least 15 basis points of tightening as soon as December of this year.
The BOE’s base rate hasn’t been above 1% since the start of 2009. Three hikes in 2022 would mark the biggest annual increase in the policy rate from the central bank since 2004.
On top of that the bank has also pledged to halt reinvestments of bonds held under its QE plan once rates hit 0.5%, meaning the moves will also lead to the start of a balance sheet reduction that will tighten policy further.
Beyond shifts in monetary policy, the U.K. government is on course to raise taxes and cut spending to control the budget deficit. Together, those moves would mark a simultaneous major tightening of both policy levers just months after the biggest recession in a century.
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