Most Read from 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 pencilled in around 65 basis points of tightening by the BOE’s December 2022 meeting, according to sterling overnight index swaps, which would take the key rate to 0.75% from 0.1% currently. The move pared to around 63 basis points as of 10 a.m. in London.
The tightening will likely be spread out over three hikes, with an initial 15-basis-point hike to 0.25% priced for February followed by an additional quarter-of-a-percentage point increase in June.
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 hiking cycle, given the economy remains in a highly uncertain position.
“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.”
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.
For their part, pound traders also seem to be focused on the economic risks. Sterling edged up 0.2% to around $1.3450 on Thursday, holding close to weakest level against the dollar since December touched on Wednesday.
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.
(Updates pricing throughout, adds analyst voice in fifth paragraph.)
Most Read from Bloomberg Businessweek
©2021 Bloomberg L.P.