Key facts
- Investors are pricing in three interest rate hikes by the Bank of England over the next two years.
- Two-year UK gilt yields have risen above 4.5 percent.
- The current Bank of England interest rate is 3.75 percent.
- Global bond market volatility and geopolitical tensions are contributing factors.
- Analysts predict UK inflation could exceed three percent in the coming months.
Investors are now anticipating three interest rate hikes from the Bank of England within the next two years, a sentiment driven by a global bond market sell-off that has caused UK gilt yields to surge. The two-year gilt yield has climbed above 4.5 percent, increasing borrowing costs and raising concerns about the UK's economic stability.
While the Bank of England's current interest rate stands at 3.75 percent, cautious tones from recent Monetary Policy Committee meetings, coupled with geopolitical risks such as a prolonged Iran war, have led analysts to believe further rate increases are likely. City analysts attribute the higher gilt yields to the UK's susceptibility to inflation shocks, further fueled by elevated global commodity prices, with Brent crude oil near $95 per barrel and European gas prices at a three-year high.
Economists generally forecast UK inflation to temporarily exceed three percent before settling back to the Bank of England's two percent target. However, the MPC has previously warned that interest rates could be raised if conflict re-emerges between Iran and the US, with a worst-case scenario projecting inflation to reach four percent.
AJ Bell analysts suggest a gradual approach to rate hikes, with investors pricing in increases in November, February, and June, potentially pushing rates to around 4.5 percent. Dan Coatsworth, head of markets at AJ Bell, noted that some investors might be adopting a waiting strategy, anticipating further yield increases if rates rise rapidly.