Bank of England floats a November rate hike if energy prices don’t come down

The Bank of England has voted 6-3 in favour of maintaining interest rates at 3.75%, but the overall message is clear: the institution is prepared to raise interest rates if energy prices remain elevated. The likelihood of a November rate hike heavily depends on a decrease in oil and natural gas prices. The Bank's global outlook assumes such a decrease, which would allow them to keep rates stable and potentially lower them by 2027.

However, should their assumption prove incorrect, a November rate hike appears inevitable. In short, the situation suggests that market projections of four interest rate increases within the next year may be excessive. A particularly noteworthy point is that the Bank now anticipates inflation peaking slightly above 4% early next year.

This prediction stems from the potential 25% increase in the household energy cap in January if natural gas prices stay as they are now. Research by the BoE indicates that inflation exceeding 4% might lead to second-round effects. Deputy Governor Sarah Breeden, one of the three who voted to maintain rates, echoed this sentiment, acknowledging that inflation is nearing "levels associated with non-linear effects."

The central question now is whether the forecast of 4%+ inflation holds true in November. However, the current evidence does not suggest that the surge in fuel and household energy costs is trickling down to other components of the inflation index. The gauge tracking inflation for energy-intensive goods and services has actually declined this year, while food inflation is decreasing, contrary to expectations.

Some of this could be due to delays, but we doubt the trend will significantly change over the next six weeks. Today's decision underscores that most officials still concur with this outlook. If the Bank does decide to raise rates in November, as Governor Andrew Bailey suggested, it won't be due to economic data between now and November.

Rather, it will be a precautionary measure, and it's intriguing that those who voted for a rate increase at today's meeting frame it as 'risk management'. This is significant because, unlike the US or even the eurozone, where there's an ongoing debate on whether interest rates are restrictive, making such an argument in the UK is much more challenging.

The job market is weaker, fiscal policy is tighter, and rate-sensitive sectors are facing more apparent pressure. Most of those voting to keep rates on hold emphasized that financial conditions are already exerting downward pressure on economic activity. In contrast, Kevin Warsh at the Fed stated that the central bank was easing a "dose of accommodation."

The case for raising UK rates remains far from compelling. Although we are not dismissing the possibility of a rate hike later this year if energy prices stay high, market pricing for the Bank of England seems disconnected from the current economic reality. This assessment is based on information provided by ING.