Bank of England set for peak interest rate hike but odds on pause rise

The surprise fall in UK inflation has seen money markets increase bets on a pause

Governor of the Bank of England Andrew Bailey interest rate
The Bank of England has already increased interest rates 14 consecutive times in a bid to bring inflation back to its 2% target. Photo: Alastair Grant/Pool via Reuters

The Bank of England (BoE) is set to increase interest rates to 5.5% on Thursday, in what is likely to be its final hike as UK inflation slowed to 6.7% in the year to August, down from July’s 6.8%, despite a rise in fuel prices.

Financial markets are betting on a 54% chance Threadneedle Street will raise the cost of borrowing by 25 basis points, with no further prospect of a rate cut until next summer.

However, the odds of a hike have fallen, with increased bets that there may be a pause after the better-than-expected inflation reading from the Office for National Statistics (ONS) on Wednesday.

Wes Wilkes, chief executive of wealth manager Net-Worth Ntwrk, said: “The sigh of relief from the BoE will no doubt be heard across the city and should be enough for a pause tomorrow”.

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Although the Bank is likely to hold on upping interest rates further after September's meeting, economists have warned that future hikes are not completely off the table.

"The BoE could be forced to take further action if inflation remains tilted to the upside," Myron Jobson, senior personal finance analyst at Interactive Investor, cautioned.

"If another rate rise is to be avoided, the Bank will need to see sustained evidence over the coming months that the 515 basis points rise in interest rates enacted since March 2020 is significantly feeding through to dampen underlying inflationary pressures."

The Monetary Policy Committee (MPC) has already increased rates 14 consecutive times to the current level of 5.25% — a 15-year high — in a bid to bring inflation back to its 2% target.

Core inflation, which strips out energy, food, alcohol and tobacco, dropped to 6.2% in August, the ONS revealed. This is a sharp fall from the July's CPI figure, which came in at 6.9%.

Read more: Euro area inflation lower than expected in August but still above ECB target

But UK interest rates are still above the likes of other nations, and progress in bringing it down has been far slower. The US currently stands at 3.8%.

In addition to this, recent UK wage inflation data hit 8.5% per annum, pointing to inflationary risks.

“We believe the Bank will look to create a dovish hike, probably increasing rates by 0.25% and giving the impression they are done on rate hikes," Paul Skinner, managing director and investment director at Wellington Management, said.

“The BoE would love us to think the job is done, however we believe that while inflation might show some short-term moderation it is going to be sticky and difficult to get back into the required range.”

Watch: How does inflation affect interest rates?

Meanwhile, Jack Meaning, chief UK economist of Barclays (BARC.L) said: "While we expect the critical mass of the committee to be grouped around a 25 basis-point hike, the uncertain, finely balanced nature of the turning point in the cycle means we believe there will be dissenters on both sides."

A 0.25% hike will benefit savers but mean that borrowing for both businesses and consumers will become even more expensive.

Samuel Mather-Holgate of advisory firm Mather & Murray Financial said: "[The ONS] data is great news for anyone with a mortgage.

"Inflation was expected to increase this month, but both headline and core rates have reversed, giving the BoE reason to keep rates on hold as opposed to hike them again, as was expected. More mortgage rate cuts are now likely."

Read more: Where to find the best mortgage rates

On Thursday, the bank is also set to update investors on quantitative tightening — its plans to unload its stockpile of British government bonds in the year ahead.

Most economists are predicting that it will increase the pace to around £100bn ($123.80bn) per year, from £80bn pounds over the last year.

Last week, the European Central Bank hiked interest rates again by 25 basis points to 4%, making it the highest level since the euro was launched in 1999.

Watch: What is a recession and how do we spot one?

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