BoE Rate Hikes Predicted as Inflation Concerns Grow

Deutsche Bank has updated its forecast for interest rate hikes by the Bank of England (BoE), now predicting two quarter-point increases in November and February. This change comes after the BoE's September policy decision, which suggested a waning tolerance for elevated inflation.

The economists at Deutsche Bank believe these hikes will be 'insurance hikes' rather than the start of a sustained tightening cycle, with the outlook still dependent on energy prices. The UK's inflation rate has been rising, reaching just over 3% year-on-year in August and expected to reach around 4% by year-end.

Bank Governor Andrew Bailey attributed almost all of the rise in consumer prices since the Middle East conflict began to higher energy prices. Headline inflation has surpassed core inflation, standing at 3.1% versus 2.6%. Meanwhile, Deutsche Bank's measures of domestically generated inflation have barely moved in recent months.

The September minutes from the BoE played down stronger-than-expected activity data, describing the economy as 'somewhat more resilient' despite growth running at close to a 2.5% annualised pace. The labour market remains weak, with spare capacity still present. The minutes also pointed to limited signs of second-round effects in firms' price expectations, wage expectations, and early 2027 pay settlements.

Deutsche Bank's Taylor Rule estimates suggest the appropriate policy rate is only slightly above 4%. Based on a simple scaling exercise, the current energy shock would imply about 50 basis points of tightening, compared to the 515 basis points delivered during the 2022 hiking cycle. If energy prices fall sharply in coming weeks, the case for further hikes will weaken.