BoE Signals Low Bar for Rate Hikes Amid Global Tensions

The Bank of England (BoE) has kept interest rates at 3.75%, as widely expected, but signaled a low bar for further tightening. In its statement, Governor Andrew Bailey warned that if the Middle East conflict persists and second-round effects emerge, policy may have to tighten.

However, there's been little evidence of material second-round effects in price and wage-setting, with easing UK wage growth and services inflation giving the BoE room to stand pat. The BoE also announced plans to slow the pace of quantitative tightening (QT) with a predictable multiyear plan.

The slower QT runoff pace supports gilts, but elevated energy prices remain the bigger driver. Unless energy prices ease in a sustainable way, gilt yields will stay under upward pressure. In contrast, markets are pricing in about 100bps of BoE rate hikes in the next twelve months to 4.75%.

According to Brown Brothers Harriman's Elias Haddad, the UK economy is already operating below capacity, and Bank Rate at 3.75% is near the top of the BoE's estimated 2% to 4% neutral range. As such, he believes the BoE may not need to tighten as much as markets expect.