Bank of England preview: first hike to 4% expected as energy pushes inflation to 3.5%

What happened

The Bank of England (BoE) is widely expected to raise its key interest rate by 25 basis points to 4% on Thursday. This would mark the first rate hike of this cycle, with the decision due at 12:00 GMT (07:00 ET). The move follows a closely divided September meeting, where the Monetary Policy Committee held the Bank Rate at 3.75% in a 6-3 vote, with three members already favouring a rise to 4%.

Since then, the inflation picture has deteriorated. Consumer prices rose 3.5% in the year to September, up from 3.1% in August, driven largely by rising fuel costs. Markets have almost fully priced in a hike, and research houses are close to unanimous.

Goldman Sachs expects a 7-2 vote in favour, a split shared by much of the consensus, with the two likely dissenters preferring to hold. Some forecasters see a narrower margin.

Why it matters

The more important question for markets is what comes next. Money markets have priced in several further increases over the coming year, a path many economists consider too aggressive. The more common base case is one additional quarter-point rise early next year, taking Bank Rate to 4.25%, possibly in February, when inflation is projected to peak.

The BoE will also publish updated inflation projections, which are likely to show a higher near-term inflation peak, possibly above 4% in the first half of 2027. The persistence of energy shocks and the risk that higher energy costs become embedded in wages and price-setting are the central concerns for the hawks.

On the other hand, wage growth has been described as soft and the consumer is under pressure, giving the doves grounds for caution.

Market impact

Interest rates and bonds: Short-term gilts could rally if the BoE pushes back on market pricing for several more hikes, particularly at the short end. If the central bank signals readiness to respond to inflation pressures without giving strong steer on future meetings, the reaction could be mixed.

Dollar and currency: Sterling's reaction will hinge more on the vote split and future guidance than the hike itself. A cautious message alongside the widely expected increase could see markets pare back their more aggressive pricing, while any sign of a faster pace would reinforce it.

Commodities: Oil and gas prices running above the Bank's previous adverse scenario raise the risk that the Middle East conflict leaves a more lasting mark on UK inflation. Any easing in Middle East tensions would weaken the case for a second move.

What to watch

Investors will be closely watching the vote split on the monetary policy decision and the statements accompanying the release of the Monetary Policy Report. The new inflation projections and the overall tone of the statement will be crucial for understanding the BoE's future expectations.

Scenarios

Base Case: BoE hikes by 0.25 p.p. to 4%, with a 7-2 vote split and cautious guidance, indicating a potential additional hike in early 2027. Sterling may see a moderate reaction. Risk Case: A narrower vote split (e.g., 5-4) or more aggressive guidance, suggesting more hikes are coming soon. This could strengthen sterling and pressure interest rates.

Original source: ForexLive (InvestingLive). For information only, not investment advice.