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Economists do not expect the Bank of England to raise interest rates this year in response to the energy shock, even though traders have rushed to price in higher borrowing costs in recent days.
On Monday morning, traders in swaps markets were betting the BoE would raise interest rates four times by the end of 2026 to contain the inflationary impact of the Iran war.
Even after Donald Trump hailed “productive” talks with Iran, prompting a market rebound, pricing still pointed to at least two rate hikes, which would take the key policy rate to 4.25 per cent by December.
Yet out of 15 economists contacted by the FT on Monday, more than half said they expected the BoE to keep interest rates at 3.75 per cent for the rest of the year, so long as energy prices did not climb further.
A further four expected the central bank to resume rate cuts before the end of 2026 as the shock led to even weaker growth and mounting job losses.
“Unlike in 2022, we think that this energy price shock will drag inflation down in the medium term,” said Andrew Wishart, economist at Berenberg.
Although some prices will jump in the short term, more persistent inflationary effects “are only plausible when firms have pricing power and workers have bargaining power . . . neither is the case now”, Wishart added.
The disconnect between market pricing and economists’ expectations is striking, coming just days after the BoE Monetary Policy Committee voted unanimously to hold rates and declared itself “ready to act as necessary” to keep inflation on track to meet its 2 per cent target.
The message that traders took from this was that the BoE “is ready to hike and ready to hike a lot . . . it was as hawkish as you can get,” said Moyeen Islam, head of UK rates strategy at Barclays.
The swing in market pricing had also been amplified by investors who had previously bet on rate cuts unwinding their positions, he added.
Even before Monday’s market swings, some economists had criticised the central bank for clumsy communication in its emphasising of the risks of a new wage-price spiral while playing down the potential for weaker growth and employment to pull down inflation in the medium term.
The MPC “fumbled the ball,” said Erik Nielsen, an independent economist. The new unanimity among the MPC’s members, who have long held differing views, gave the impression of “a clear hawkish shift” and made governor Andrew Bailey’s “already difficult task nearly impossible”.
UK policymakers have good reason to highlight the risks of high inflation becoming entrenched in households’ consciousness.
“The MPC will have to be careful. Inflation has been running above target almost continuously for five years and credibility in the central bank is low,” said Robert Wood, chief UK economist at the consultancy Pantheon Macroeconomics.
He argued that the correct course for the MPC would be to hold rates, but said hikes now looked more likely than cuts.
Edward Allenby, at the consultancy Oxford Economics, said that markets had misinterpreted the MPC’s message, with the unanimous vote “reflecting the heightened level of uncertainty . . . rather than the very hawkish signal that markets appeared to have latched on to”.