The Bank of England could be forced to raise interest rates to 4% as early as next year to tackle soaring inflation, despite the growing risk of recession amid the cost of living crisis .
Traders in the city are betting the central bank will more than double the cost of borrowing by 1.75% in response to inflation at the highest level in more than 40 years.
In a development that will put renewed pressure on mortgage holders, the Bank’s key rate is expected to reach 4% by May 2023, based on the implied trajectory of financial markets.
The base rate is expected to end the year above 3% and could peak near 4.1% in June 2023, based on interest rate derivatives linked to Threadneedle Street monetary policy committee meeting dates. The Bank is then expected to cut rates to around 3.8% by the end of next year amid expectations of easing inflationary pressures and a long recession.
The moves in the financial markets come as mortgage lenders raise the rates they offer borrowers. Figures from data provider Moneyfacts showed the average for new two-year fixed-rate mortgages rose above 4% for the first time since 2013 at the start of this month. Lenders set their rates based on the central bank’s base rate and financial market conditions, and in competition with other providers.
Expectations of a dramatic rise in borrowing costs come with inflation above double digits for the first time since the 1980s. Some City economists predict a peak above 18% next January, fueled by a sharp increase in household energy bills expected in October and early next year.
The Bank raised rates by 0.5 percentage points this month, the biggest hike in nearly 30 years. Rate expectations reaching 4% would likely necessitate similar increases in borrowing costs.
Threadneedle Street’s government target is to keep inflation down to 2%. He has come under heavy criticism in the Tory leadership race after Liz Truss said she could change her term to bring inflation under control.
On the implied trajectory of financial markets, the Bank would raise the cost of borrowing by more than the US Federal Reserve, with traders betting that interest rates would peak at nearly 3.8% in March next year.
However, expectations of higher interest rates could be tempered by a more pronounced slowdown in the UK economy, amid early warning signs that the UK economy is heading into a long recession.
Two separate snapshots of industrial activity released on Tuesday showed a decline in manufacturing activity, amid fears that the soaring cost of living will force households to cut spending to meet higher energy bills .