Hawkish Bank of England propels rate hike expectations

The Bank of England has voted unanimously to keep rates on hold at 3.75%, opening the floodgates for markets to price in more rate hikes. At the time of writing, two-year rate expectations are 25bp higher – representing a full extra hike priced in – since the minutes before the announcement.

Yet we shouldn’t get too carried away by what this decision tells us about future policy. Yes, the Bank has opened the door to a hike – and crucially, so have some of the arch-doves. That is what markets are understandably latching onto. But, importantly, the Bank also concedes this is a very different economic environment from 2022. It doesn’t rule out this crisis fostering a greater need to lower rates further, either.

Nor should we read too much into the unanimous vote behind today’s decision. Most likely, the same fault lines that had become very visible over recent months will re-emerge.

Ultimately, the central message is that the Bank, like the rest of us, has no idea where the disruption ends. It’s only prudent to keep its options open and see where things land in April.

Under ING’s base case, which has Brent crude averaging US$91/bbl and Dutch TTF gas averaging €50/MWh in the second quarter, we’d expect UK inflation to peak between 3.5-4% in the autumn. If today’s prices persist into the summer, then we’d potentially be looking at 5%. Crucially, those forecasts are before we consider the wider fallout in services inflation.

That is clearly the scenario the Bank is worried about here. Chief Economist Huw Pill has often cited 4% as a threshold for inflation, above which statistically we’re more likely to enter a period of sustained price pressure. In a scenario where energy prices stay at or above today’s levels for a prolonged period, the message from today is that rate hikes are highly likely.

The Bank’s reaction will also depend on what, if anything, the UK government does to cushion consumers against rising energy bills. That more extreme scenario, where natural gas prices stay at current levels for some time, would likely take the average household energy bill above £2,500, which was the level the UK government capped them back in 2022. But with borrowing costs considerably higher than four years ago, the Treasury’s ability to step in is much more constrained.

Fundamentally, our view is that this crisis is more likely to manifest itself in higher unemployment than in significant second-round effects on inflation.

Setting out a clear base case for the Bank in these volatile times is clearly difficult. But in a scenario where prices do settle a bit lower into Q2 – aligned with ING’s wider energy base case – then we think the bar to hike is probably higher than markets think. In that scenario, we suspect we’d be looking at a prolonged pause.