Markets price in four Bank of England rate hikes this year

by | Jan 27, 2022

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  • Financial markets are currently pricing in a 95% chance of a UK interest rate rise to 0.5% next Thursday
  • Also priced in are a total of four interest rate hikes this year, taking base rate from 0.25% to 1.25%
  • If realised, that would take interest rates to their highest level since February 2009
  • An estimated 10 million Britons have never seen base rate above 1% in their adult lives*
  • But this wouldn’t be the first time markets have got ahead of themselves when it comes to predicting interest rate hikes
  • The impact of rising interest rates on funds, markets and investors

*sources: AJ Bell, ONS

Laith Khalaf, head of investment analysis at AJ Bell, comments:

“It’s not just in the US where the prospects for tighter monetary policy are escalating, markets are also expecting a significant number of rate hikes in the UK this year. A rate rise at the Bank’s February meeting is all but inked in, which if realised would be the first time since 2004 that the bank has raised interest rates in two consecutive meetings. Market pricing suggests a further three hikes this year, taking base rate to 1.25% by the end of 2022, which would be its highest level since February 2009, just before an ‘emergency’ rate of 0.5% and QE were introduced.


“Rampant inflation is of course the reason markets are now expecting the Bank of England to start pressing on the monetary policy brakes. It’s a startling sign of how dramatically the economic outlook has changed in the last twelve months to consider that this time last year, the rate setting committee was talking about a negative base rate in the UK. Fast forward to 2022, and the market is thinking four rate rises could materialise this year alone.

“This would be a paradigm shift for investors, businesses and consumers, all of which have become accustomed to a prolonged period of extremely accommodative monetary policy. Indeed we estimate that 10 million people in the UK haven’t seen base rate above 1% in their entire adult lives. Little wonder then, that markets are getting in a bit of a tailspin about what rising interest rates might mean for stocks and bonds. The Chancellor might also be squirming in his seat. Higher base rate will mean the Exchequer needs to pay significantly more interest on the £875 billion of gilts held in the QE scheme, and that could have significant implications for the viability of any largesse the Chancellor might like to indulge in at the March Budget.

“Market pricing can change pretty quickly, and of course, this wouldn’t be the first time markets have got ahead of themselves when it comes to betting on rate rises that never materialised. Last November, markets were certain we were going to get a rate hike, but seven out of nine committee members voted to keep rates on hold. Today though, consistently high inflation and a buoyant labour market make a prima facie case for tighter monetary policy, and having raised rates in December, the Bank’s policy setting committee has some momentum behind it.


“The Bank of England can’t control the major factors that will push inflation up in the immediate future, such as global energy prices or elevated shipping costs. But a February rate hike would help persuade the market that the Bank really means business, and help to stave off embedded inflationary expectations that could spark a dreaded wage-price spiral. A rate rise would be doubly significant because base rate would cross the minimum 0.5% threshold the Bank of England has set before it considers unwinding the QE scheme, which opens the door for Quantitative Tightening to take place. If you’re a long-dated gilt investor, you might want to hold on to your tin hat.

“Over the course of the rest of the year the Bank may prove more circumspect than the market is currently anticipating. There could yet be some relief from inflationary pressures later in the year if supply chains normalise and energy prices fall back, perhaps for instance if there is a peaceful solution to the Ukraine crisis. The Bank may also want to see how the effects of tighter policy play out in the economy for a while, before cranking the handle too many times in a row. Nonetheless, 2022 does look like it’s going to be the year when the monetary policy worm finally turns, and that will have wide ranging implications for consumers, businesses and markets.”

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