A Bank of England rate hike on Thursday is all but certain; how many more will follow? Markets and economists are clearly divided.

With UK inflation approaching 4% and the Iran war showing no sign of ending, a Bank of England rate hike on Thursday is all but certain. But how many more hikes will follow, economists and investors are clearly divided. In the first scenario, after delivering the first rate increase since 2023 this week, the Bank of England would raise rates three more times before the end of next summer. Resilient UK economic growth, a stabilizing labor market, and an energy shock that has worsened further in recent weeks would force the Monetary Policy Committee to lift Bank Rate to at least 4.75% an outcome that has been priced by money markets since early September. The alternative scenario and the economists' consensus points to a hike to 4% this week, followed by only a 50% probability of another increase in the first quarter of 2027. The case for this view rests on signs that consumers are beginning to tighten spending and that there is currently little evidence the energy shock is triggering a price feedback loop. UK government bonds could rally if policymakers push back against prolonged tightening, especially shorter-dated maturities whose yields have already hit three-year highs. Alternatively, the Bank of England may leave investors waiting for clearer signals on future rates, since current market pricing is already helping it combat inflation by pushing up household and corporate borrowing costs. Market pricing and economist forecasts clearly diverge "Everyone had been expecting energy prices to fall back and had built their inflation and Bank Rate forecasts on that basis," said Paul Dales, chief UK economist at Capital Economics. "That's why economists generally don't think there will be too many rate hikes and expect rates to come back down. But we're now in an environment where if energy prices stay around current levels for another six months or so, rates will probably be higher." Bank of America strategists noted a 0.55 percentage point gap between market pricing and the bank's economists' forecast for Bank Rate, among the largest gaps in major economies. The Bank of England has said that investors demanding compensation for rising risks to the rate outlook partly explains the aggressiveness of the market curve. But even one of the BoE's most hawkish policymakers, Chief Economist Huw Pill, warned that he is "skeptical" about the need for four rate hikes. Rate strategists at Bank of America and Citigroup attribute the gap to risks that energy prices continue to rise, the Iran war shows no sign of ending, and the UK economy keeps outperforming expectations. August GDP unexpectedly grew for a third consecutive month, signaling third-quarter expansion well above the BoE's July forecast of 0.1%. Elias Haddad, head of global market strategy at Brown Brothers Harriman, said this makes the BoE's communication around market pricing, and its corresponding forecasts for inflation and the UK economy, "key to assessing the scope for rate hikes after this week." Mark Cabana and others at Bank of America strategists said that pushing back against "excessive" market pricing could produce a "bull steepening" of the UK curve, in which short-end bond yields fall more than long-end yields. A decision with "no surprises" After UK Chancellor John Healey's first budget last week was largely absorbed by the market, the Bank of England may also want this decision to be uneventful. With markets expecting multiple rate hikes, financial conditions have tightened, allowing the BoE to stay put and lag the Federal Reserve and European Central Bank in policy action. However, policymakers know that expectations ultimately need action to support or recalibrate them. BoE Governor Andrew Bailey poured cold water on market bets in the spring, when traders priced as many as four rate hikes. Both Bailey and Deputy Governor Sarah Breeden have pointed to signs that companies are cutting costs to cope with the energy shock rather than passing price increases on to consumers. And that was even before the BoE published a surprisingly dovish private-sector survey last week. With consumers under pressure, many businesses are finding it difficult to raise prices, and so far few of the executives surveyed plan to raise wages next year to counter the inflation shock, suggesting second-round effects remain limited for now. "The Monetary Policy Committee will likely push back gently against market pricing," said Dani Stoilova, economist at BNP Paribas. Policymakers "may use the tightening in UK financial conditions and limited evidence of second-round effects to justify a less aggressive path."