Markets price in multiple rate rises as inflation increases to 3.1%

A second successive rise in CPI inflation has increased pressure on the Bank of England to raise interest rates this year.

Headline inflation rose to 3.1% in August, up from 2.9% in July, largely driven by rising oil and gas prices.

Despite mounting pressure on the Bank's Monetary Policy Committee, a hold at 3.75% is still expected tomorrow. However, the decision is expected to be a tight split, with three members already voting for an increase at last month's meeting.

The bigger shift is happening in expectations for the months ahead, with markets now pricing in multiple hikes as high energy prices threaten to keep inflation elevated. Economists widely predict two hikes in November and February, but say a rate rise is not completely off the table for tomorrow.

Rob Morgan, chief investment analyst at Charles Stanley Direct, commented: "Surging energy prices spell more pain in the pipeline for UK consumers and greater pressure on the Bank of England to raise interest rates. With the US Fed perhaps poised to hike, and the ECB having already done so, there is now an expectation that the BoE will need to follow suit in the not-too-distant future.

"While policymakers are expected to stand pat tomorrow, albeit with a heavily split vote, the time could well come next time around assuming no reprieve for energy markets from the conflicts in the Middle East."

Samuel Fuller, Director of Financial Markets Online, said: “Six months on from the start of America’s conflict with Iran, there’s no end in sight to the fighting and its interruption of global oil supplies. Wholesale gas prices are high too, and consumers face a surge in their energy bills next month.

“In other words, inflation is high now and there’s a real risk it will get worse if left unchecked.

“All this means the Bank of England may feel it has little choice but to raise interest rates in order to tame the UK’s worsening inflation problem - the only question now is when.

“At the start of September, few expected the Bank to raise interest rates this month. But today’s surge in CPI means the chances of the Bank’s Monetary Policy Committee voting for an immediate rise when it meets tomorrow could be as high as 50/50."

Emma Hollingworth, chief distribution officer at LSL Financial Services, commented: “While the Bank of England has held its nerve on interest rates since the US-Iran conflict flared up again, today's inflation data has significantly raised the odds that it will hike borrowing costs this year.

"The European Central Bank increased rates last week, albeit from a lower base, and markets expect the US Federal Reserve to follow suit later today. That piles the pressure on the Bank’s Monetary Policy Committee to act sooner rather than later.

"We still think a hold is the most likely outcome on Thursday, but the decision will be close and the MPC could easily vote to raise rates if it feels the need to head off further price pressures.

Richard Carter, head of fixed interest research at Quilter Cheviot, added: "Today’s figures put a rate hike into the category of a genuine consideration, with at least one expected this year. Markets have begun to price in the potential for further rate hikes into 2027, highlighting that the UK has struggled to tame inflation recently and is not expected to do so soon this time around either. The expected pace of the rate hikes may be slightly exaggerated at this point by the market, but really the only thing potentially stopping the BoE from hiking this time around is the employment picture, which remains mixed at best."