Interest rate stability could be coming to an end as markets price in hikes

The Bank of England is expected to keep interest rates at 3.75% this week. However, financial markets are increasingly betting that the next move will be upwards as inflation pressures intensify.

The Monetary Policy Committee (MPC) is widely expected to leave Bank Rate unchanged on Thursday. It would be the sixth consecutive meeting without a change. Rates have remained at 3.75% since December.

But attention is shifting from this week’s decision to how soon the Bank may be forced to act.

Money markets are now pricing in as many as four quarter-point increases by July next year. If delivered, that would take Bank Rate to 4.75% in less than 12 months.

Such a move could put renewed upward pressure on mortgage rates and housing affordability.

The change in expectations follows stronger economic growth and renewed concerns about inflation.

Official figures showed the UK economy unexpectedly grew by 0.4% in July. Economists had forecast that growth would stall.

The stronger performance suggests the economy may be better placed to withstand higher borrowing costs.

Meanwhile, Consumer Prices Index (CPI) inflation rose to 2.9% in July, up from 2.6% in June. It was the highest level since March.

Further pressure is expected when Ofgem’s new energy price cap takes effect in October. Bills will increase by 4% for a typical dual-fuel household.

Higher global energy prices have added to concerns about the inflation outlook.

For estate agents, buyers and sellers, renewed rate rises would mark a significant shift after months of Bank Rate stability.

The MPC is nevertheless expected to adopt a wait-and-see approach this week. Policymakers are assessing the economic impact of the Middle East conflict and higher energy costs.

Divisions within the nine-member committee are already apparent.

Huw Pill, Megan Greene and Catherine Mann voted to increase Bank Rate to 4% at the previous meeting. Economists expect the three policymakers to support another immediate rise this week.

Matt Swannell, chief economic adviser to the Item Club, said: “It looks a near certainty that the MPC will leave Bank rate unchanged at 3.75%.

“However, we expect divisions among rate-setters to remain, with July’s three hawks – Huw Pill, Catherine Mann and Megan Greene – again favouring an immediate rate increase.

“With the decision largely seen as a done deal, attention will instead focus on the committee’s communications, particularly on whether the doves have moved towards accepting the possibility of future rate rises.”

There are some signs that underlying inflationary pressures remain contained.

Services inflation fell from 3.6% to 3.4%. That reduces evidence, so far, that higher costs are feeding more broadly into wages and prices.

But economists increasingly believe the Bank may have to respond if the energy shock persists.

Pantheon Economics said the MPC could “toughen its language” this week. That could leave the door open to an increase as soon as November.

“A 4% inflation peak would already be too hot to hold, but further energy price rises could take inflation even higher,” its economists said.

“The MPC needs to be ready.”

Thomas Pugh, chief economist at RSM UK, said policymakers would need to act if higher inflation feeds through into wages and business prices.

“The problem is that the energy shock is becoming harder to look through. Higher energy prices will lift headline inflation over the coming months,” he said.

Pugh expects inflation to peak at almost 4% in 2027.

The surprisingly strong July GDP figures have added another dimension to the debate.

Susannah Streeter, chief investment strategist at Wealth Club, said the data made an increase before Christmas “a touch more likely”.

“The big worry is that higher energy costs will be passed on as higher prices by businesses and consumers, but it’s likely that the committee will want to see more evidence of that before triggering rate hikes.

“Given the turmoil in energy and bond markets, however, there is an expectation that we could see three to even four rate hikes over the next year.”

The European Central Bank has also shifted rates upwards. It raised interest rates for the second time this year last week, citing inflationary pressures linked to the Iran war.

UK borrowing costs eased on Friday after reaching 19-year highs the previous day. The yield on 10-year gilts fell two basis points to 5.351%.

Brent crude also retreated by more than 2.5% on Friday to below $105 a barrel. That followed sharp increases earlier in the week.

Thursday’s Bank of England decision may therefore contain little immediate surprise.

The bigger question for the property market is what happens next. Agents and borrowers will be watching for signs that the period of interest rate stability is coming to an end.