Markets anticipating two three-quarter-point BOE hikes by year end

LONDON (Sept 20): Traders are rapidly dialing up rate-hike wagers for the UK, betting the Bank of England (BOE) will deliver two outsized increases by the end of the year to quell rampant inflation stoked by surging energy prices.

Money markets have priced in 200 basis points (bps) of hikes over the next three decisions, implying the BOE will raise rates by three-quarter points at two of those meetings. The first such move could come as early as this week, with traders placing around a 60% chance of a 75 bps increase on Thursday. That would be the bank's largest increase since 1989, when it jacked up borrowing costs by a full percentage point.

The scale of tightening priced suggests traders expect the key rate will rise to 3.75% by year end and 4.5% as soon as March, around 80 bps more that what was expected a month ago.

The repricing comes as central banks including the European Central Bank (ECB) and the Federal Reserve (Fed) ratchet up the size of their rate hikes, front-loading tightening to keep a lid on inflation expectations. Sweden's Riksbank on Tuesday unexpectedly raised rates by one percentage point, its most aggressive tightening in almost three decades of inflation targeting.

Fears that Russia will continue to curb gas supplies have driven a surge in energy prices across Europe, with benchmark gas in the region trading six times its historical average. The prospect of fresh stimulus from the UK government threatens to add to price pressures in the longer term, fuelling concern the BOE will struggle to bring inflation — running at just under 10% — back to target unless it too takes more aggressive action.

"The BOE appears much more concerned about today's high inflation and tackling that, even if that comes at the expense of weaker growth," said Imogen Bachra, UK rates strategist at NatWest Markets. While her base case is for the BOE to opt for 50 bps at this week's decision, she said the additional fiscal boost should mean a "slightly more hawkish reaction" than previously anticipated.

Shorter-dated maturities led a slump in UK bonds on Tuesday, with two-year gilt yields surging as much as 12 bps to 3.26%. Benchmark 10-year yields rose to the highest level since 2011.

Traders also see further jumbo hikes by other central banks. Money market pricing implies an over 80% chance of a second 75 bps hike from the ECB at its rate decision in October. Such a move is already fully baked in for the Fed rate decision on Wednesday, with traders placing around 16% odds of a one-percentage-point hike.

Still, markets are betting that rate hikes in the UK will be put into reverse after the BOE rate peaks by mid-2023. Traders are pricing in about 14 bps of easing by the end of next year.