City traders are betting on two interest rate hikes before the end of the year following the Bank of England’s decision to hold at 3.75% on Thursday and issue hawkish warnings about the Iran war’s energy price impact on UK inflation. Financial markets moved decisively after the announcement, with swap pricing now reflecting a high probability of a quarter-point rise in June and a further increase before December. The monetary policy committee voted unanimously to hold, but the hawkish tone of its communication gave traders all the signal they needed to reprice their expectations.
The basis for the market bet on two hikes lies in the changed inflation outlook created by the US-Israel conflict against Iran. Before the war, markets had been pricing in rate cuts. The energy price spike triggered by the conflict has completely reversed that expectation, with the Bank now projecting inflation to rise toward 3.5% in March and remain above its 2% target throughout 2026.
Governor Andrew Bailey attempted to moderate the hawkish interpretation of the Bank’s communication, cautioning against assuming rate hikes were certain or imminent. He said the Bank was in assessment mode and would be guided by how events in the Middle East and their economic consequences developed. His moderating language, however, was not enough to deter traders from making their bets on a June move.
UK gilt yields rose, the FTSE 100 fell, and the pound strengthened against the dollar in the aftermath of the announcement. Analysts described the market reaction as rational given the hawkish content of the Bank’s statement and the scale of the energy price disruption caused by the war. Five-year fixed mortgage rates continued their upward trend.
For UK households and businesses, the market bet on two hikes translates into a more expensive borrowing environment than had been anticipated at the start of the year. Whether the Bank follows through on that expectation will depend on how the Iran conflict evolves and what happens to UK inflation in the weeks ahead. The next set of inflation data will be among the most closely watched economic releases of the year.
