Traders Price Three BOE Hikes Next Year, See Key Rate at 0.75%

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Traders are pricing in 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 now see around 65 basis points of tightening by the BOE’s December 2022 meeting, according to sterling overnight index swaps. That means they’re betting the key rate will rise to 0.75% next year from 0.1% currently.

The BOE expects inflation to climb to more than double its 2% target by the end of the year, largely driven by a surge in energy prices. The measure jumped more than expected to the strongest pace in more than nine years in August.

“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 surprised investors last week when they left the door open for a potential rate hike as soon as November. Still, policy makers may yet be too cautious to pursue an aggressive hiking cycle, given the economy remains in a highly uncertain position.

They 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 recover.

“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.

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.

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