Bank of England rate decisions: Hawkish hike, but energy price trajectory key for the outlook

The economist view

As was widely expected, the Bank of England (BoE) raised rates 25bp to 4.0%. The vote was 8-1, although all nine members supported a rate increase, as the sole dissenter, Catherine Mann, preferred a larger 50bp hike.

For now, again as we’d have expected, this hike sounds more part of a risk management strategy than it does the start of a big hiking cycle.”

The rationale for the hike was very much as expected – the outlook for inflation has worsened. The Committee already sounded much closer to a hike in September and ready to hike rates if energy prices stayed elevated, which they duly did. For now, again as we’d have expected, this hike sounds more part of a risk management strategy than it does the start of a big hiking cycle.

It was clear though that the trajectory of energy prices remains important for their decision-making. Governor Andrew Bailey’s comments relating to lower oil prices over the last 48 hours gave the impression the move would not have changed today’s decision to hike, but suggested that, if those moves continue, the likelihood of further rate rises would diminish.

Why hike?

There were three main reasons given for today’s hike:

• Inflation outlook worsened: Energy prices have risen further than the BoE had assumed, while inflation has been stronger than the bank had forecast back in July. The bank now expects inflation to rise to 4.5% in Q1 next year, before peaking at around 5% in Q2. That is much stronger than it had forecast back in July, when it expected inflation to peak at around 3.2% in 2026 Q4.
• Stronger activity data: Despite higher energy prices, the economy has been more resilient than the bank had expected. The statement notes that activity has been supported by stronger global growth and some positive impact from the deployment of AI and that there are signs of a stabilisation in the margin of slack in the economy. Some members feel that stronger-than-expected activity data indicates monetary policy settings were less restrictive than they’d previously thought.
• Increased risk of indirect and second-round effects: Combining higher than expected inflation and a more resilient economy, “the Committee judged that the risk of material second-round effects emerging had risen further since September and could remain a risk for some time.”

Despite the hawkishness of the vote, this still doesn’t sound like the start of a big hiking cycle.”

Not signalling the start of a big series of hikes

Despite the hawkishness of the vote, this still doesn’t sound like the start of a big hiking cycle. During the press conference, Governor Bailey said: “Today’s increase should not be seen as the first in an inevitable long sequence of hikes, that is not inevitable, but unless the conflict in the Middle East is resolved, neither does it seem likely to be the last increase.” There were a number of other signals that supported this not being seen by them as the start of a big hiking cycle.

• Rates are already restrictive: Most members continue to judge that the stance of monetary policy is restrictive, which should help to weigh on inflation.
• Still some slack in the economy: While activity data has been stronger than expected, most members continue to judge that it is likely “some slack would persist given the headwinds facing demand from households and firms”, which should limit the risk of second-round effects in their view.
• Still not seeing second round effects: For now, the bank is still not seeing significant evidence of second-round effects.

However, policy rules are consistent with more than one hike

Under the central scenario, the bank’s own range of policy rate rules, similar to Taylor rules (and which you could think of as being mechanical and loosely illustrative) are consistent with a few more hikes, taking Bank Rate to around 5.0%. We would not take too much from this, but they are consistent in expecting the central bank to raise rates more than once more if energy prices follow what they have in the central scenario and especially if we do see second round effects emerge.

Some sound more likely to hike rates again than others

There were clear differences highlighted in views between different members. The more hawkish members of the Committee sound ready to hike again and the doves put a relatively high hurdle in front of a further hike, but the bulk of the Committee fit between these two camps.

• The hawks (beyond Mann) sound ready to hike again. Megan Greene explicitly said in her individual comments that “Additional hikes will likely be required going forward…”, while Huw Pill said: “Of itself, a single 25-basis point hike is unlikely to be sufficient.”
• Most of them sound ready to hike if energy prices stay elevated: Those MPC members in the middle ground sounded prepared to raise rates again if energy prices remain elevated. Clare Lombardelli said that “in the absence of evidence of weaker inflation pressures, there is likely to be a case for a further increase in rates in the near term.” Governor Bailey in his individual summary said that “without news which softens the risks to inflationary pressures, I can see the argument for a further increase in rates and thereafter taking a more conditional approach, dependent on the evidence on energy prices and inflation dynamics.” Sarah Breeden said that “the longer energy prices remain high the more likely persistent inflationary effects take hold, which would require further tightening in Bank Rate. But this will also depend on how energy prices propagate.”
• The doves apply a higher hurdle to further hikes: The tone from the more dovish members was different, with a higher hurdle imposed, with Swati Dhingra, for example, arguing that “to support maintaining the Bank Rate at a higher level for an extended period, I would need to see clear evidence of a recovery in firms’ pricing power and households’ purchasing power alongside signs of mutually reinforcing wage and price pressures.” Taylor, somewhat similarly said that “further tightening…depends on continued energy price pressure…as well as unfolding evidence of propagation into domestic wages, price-setting and expectations, particularly through the 2027 pay round.”

What all this means for our forecasts? Risk of fewer hikes if energy prices continue to fall

We are expecting the BoE to hike rates twice more, with two-sided risks depending on the path of energy prices in particular. We are happy to stick to our central case for now, but if we see a continuation of the very recent energy price trend, those further rate hikes will look less likely. Governor Bailey was explicit that lower energy prices over the last 48 hours are positive news, but also pointed out that “there is already a significant amount of inflationary pressure in the pipeline.” The bank was clear of course that monetary policy “is not on a pre-set path.”

The fund manager view

At the BoE meeting on 5 November, the Monetary Policy Committee (MPC) voted 8–1 to increase Bank Rate by 0.25% to 4%, the first increase in rates in three years. The decision to raise the base rate had been widely anticipated by economists and financial markets, although consensus expectations were for a 7–2 vote, with two members voting to remain on hold.

In the end, the decision to hike was unanimous, with Catherine Mann voting for a larger 0.5% increase to 4.25%. With markets already expecting today’s move, and additional hikes over the coming six months, the more interesting part of Thursday’s meeting was always likely to be the accompanying Monetary Policy Report, and what the updated forecasts might tell us about the future path for UK interest rates. The BoE November Monetary Policy Report confirmed the 8–1 decision, with the dissent in favour of a larger increase rather than remaining on hold.

Perhaps unsurprisingly, the largest changes came in the bank’s inflation forecasts; UK CPI inflation reached 3.5% in September and is now expected to peak around 5% by the middle of next year, driven primarily by the continued increase in global energy prices. Importantly though, the bank continues to argue that there is limited evidence that higher energy prices are feeding meaningfully into other prices and wages. While the direct impact of higher energy prices is now sufficient to justify a hike in rates, it is the indirect and second-round effects that will ultimately determine how much further policy needs to tighten from here.

There were also changes elsewhere in the forecasts. Economic activity has been stronger than expected over recent months, giving the MPC slightly less reason to worry about the impact that higher rates might have on growth, while the labour market has also proved more resilient than many expected earlier in the year. Combined with the significantly higher near-term inflation profile, it is perhaps unsurprising that the MPC felt it could no longer justify keeping rates at 3.75%. At this stage, a further 0.25% hike in February looks likely. However, the bank was equally clear that monetary policy is not on a pre-set path, and that future decisions will depend on what happens to underlying wages, pricing behaviour and spare capacity within the economy. Developments around the Middle East and energy prices will clearly remain an important factor here.

The BoE continues to emphasise that there is little monetary policy can do to influence the initial energy-driven supply-side shock, which should limit how far interest rates ultimately need to rise in this cycle.”

But what does this mean for bond investors? In our September blog, we noted that markets were pricing Bank Rate to reach around 4.75% by mid-2027. Little has changed since. The inflation outlook is undoubtedly more challenging than it was in the summer, whilst the resilience of economic activity, as well as the labour market, has been a positive surprise. Combined, these probably justify some further tightening in the short term. But that is priced by markets. The BoE continues to emphasise that there is little monetary policy can do to influence the initial energy-driven supply-side shock, which should limit how far interest rates ultimately need to rise in this cycle. However, the question for gilt investors is less about whether Bank Rate reaches 4.25%, 4.5% or even higher over the coming months, and more whether rates need to remain at these levels over the medium term.

The bank itself continues to distinguish between the direct effect of higher energy prices and the indirect and second-round effects that monetary policy can influence. Earlier this year, as markets rapidly repriced the longer-term level of UK interest rates, we increased duration across our gilt strategies, particularly in five to seven-year maturities and 30-year maturity gilts. Recent developments within the UK government bond market have been positive: the Labour government has delivered a Budget focused on fiscal stability; the Bank of England has updated its plans for its Quantitative Tightening programme and all but stopped sales of longer-dated gilts back to the market; while the UK Debt Management Office (DMO) has slashed longer-maturity gilt issuance for the remainder of the fiscal year. Gilts have reacted well, particularly at the longer end of the curve, which has been beneficial for our longer-duration stance and curve positioning. Following these moves, we have subsequently reduced some of the magnitude of that duration position, particularly in longer-maturity bonds, but maintain a bias towards lower yields through five to seven-year maturity bonds.

There is likely to be plenty of volatility over the coming months, particularly while energy prices remain sensitive to developments in the Middle East. But regardless of where Bank Rate ultimately peaks in this cycle, it is the longer-term neutral rate that remains central to the valuation of UK government bonds. In our view, markets continue to place too much weight on today’s inflation shock requiring interest rates to remain structurally higher for longer. With gilt yields still close to their cycle highs, we continue to see attractive opportunities across the UK government bond market.

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