Energy and food price pressures intensify, potentially triggering an inflation comeback! The Bank of England may find it hard to remain "calm" any longer as market rate hike bets surge.

Title context: Energy and food price pressures intensify, potentially triggering an inflation comeback! The Bank of England may find it hard to remain "calm" any longer as market rate hike bets surge. Text: After July's interest rate decision, Bank of England Governor Andrew Bailey delivered an unusually blunt message to reporters: "Please don't leave this room with the idea that the Bank of England is moving toward a rate hike." But at the Bank's latest rate decision this Thursday, he may find it hard to be so categorical again. The upward pressure on energy prices from the unresolved Middle East war is gathering forceBrent crude has firmly topped $100 a barrel, and natural gas costs are an even bigger challenge for the UK. Bailey recently told lawmakers that energy prices "could go higher still." New risks are also closing in, potentially keeping inflation above the Bank of England's 2% target for most of next year. After widespread drought in the UK and the impending effects of a super El Nio, risks to food costs are emerging. Other items in consumers' shopping baskets are hardly reassuring either, such as airfares. And rapid economic growth suggests demand is stronger than expected. St James's Place chief economist Hetal Mehta said: "Energy prices have to some extent passed the baton to food prices. The broader El Nio effect is likely to make inflation more stubborn next year. Even if the Middle East-related energy price inflation does ease, you'll be layering on another wave of food price increaseswhich is precisely what prevents the headline figure from falling significantly." Traders ramp up bets on Bank of England rate hikes With inflation risks mounting, the market has adjusted accordingly. In the days after Bailey's July press conference, traders had priced in less than a full 25 basis points of Bank of England rate hikes before year-end; as of September 11, they had priced in 46 basis points of hikes before year-end and were betting on as many as four hikes by next summer. Most Bank of England officials believe the weak labor market and the expected slowdown in the second half of this year will help contain the price pressures triggered by the Middle East war. Although July's GDP data suggest the economy may be resilient, the overall evidence supports the view that second-round effects remain contained. There is currently little sign that inflation is becoming entrenched. The Bank of England's August inflation expectations survey, released last Friday, showed one-year-ahead inflation expectations fell to 3.2% from 4% in May; expectations for 12 months ahead fell to 2.9% from 3.5% in May. The Bank of England's agents' survey of businesses nationwide found that pay settlements for 2027 were "broadly flat or lower" than 2026when average increases were 3.6%. A key domestic unknown for the UK is whether the strong economic growth in the first half of this year can persist, or even prompt businesses to start hiring again. Although forecasters expect rising inflationary pressures to weigh on consumers and economic activity, surveys show that both consumer and business confidence have picked up since Andy Burnham became prime minister in July, which could add to demand in the economy. Energy bills are once again pushing up UK inflation Yet the Bank of England may have to change tack at some point. Oxford Economics estimates that UK inflationcurrently 2.9%could rise to close to 4% around the end of the year. That would be double the Bank of England's target and above the level at which the central bank believes households start to notice accelerating price increases. One key driver will be the UK energy price cap, which limits the unit energy charges suppliers can pass on to consumers. The UK regulator, the Office of Gas and Electricity Markets (Ofgem), has announced that the cap will hit a three-year high in October, and experts say it could rise further in early 2027. Oxford Economics chief UK economist Andrew Goodwin said: "We think the impact of the Middle East conflict is still accumulating. We think the price cap could rise another 13% in January. Current wholesale electricity prices are far above the level of the previous observation window." The food industry is also warning that the combination of rising energy costs, the impact of the UK's scorching weather on harvests and El Nio will push up grocery spending for most of next year. The Food and Drink Federation (FDF) expects food inflation to jump to nearly 4% before Christmas and peak at 6.4% in July 2027. FDF chief economist Liliana Danila said: "The biggest risk is really what happens with commodities, and then what impact El Nio brings." She noted that crops such as cocoa, coffee, palm oil, rice and sugar could be affected, "we could see worse than expected... although so far, we haven't seen a real impact in physical terms." UK food inflation is expected to hit its highest since early 2024 Most economists expect the Bank of England's Monetary Policy Committee (MPC) on Thursday to once again hold rates at 3.75% by a 6-3 vote. ITEM Club chief economic adviser Matt Swannell said the committee will likely "talk tough about its readiness to fight inflation to avoid any unnecessary easing in financial conditions." In addition, the Bank of England's Monetary Policy Committee is widely expected to slow the pace of shrinking its government bond portfolio to take account of the fragile state of the bond market. Since launching quantitative tightening in 2022, the Bank of England's government bond portfolio has shrunk from 875 billion to 489 billion. The market expects the Bank of England to slow the pace of reduction from 70 billion over the previous 12 months to 50 billion over the next 12 months starting in October.