- Financial markets are pricing in several UK interest rate rises, potentially taking the Bank of England's base rate to 4.75 per cent or 5 per cent.
- Economists at Deutsche Bank, ING and Oxford Economics expect a more modest increase, with forecasts pointing towards a peak of around 4.25 per cent.
- Higher energy prices and uncertainty over inflation are driving market expectations, but analysts say some of the projected increases reflect investors' caution rather than the most likely outcome.
UK interest rates could rise less sharply than financial markets currently expect, according to City economists who question whether the Bank of England will need to increase its base rate to 5 per cent by the end of 2027.
Markets are pricing in at least four rate rises over the coming year, potentially taking the bank rate from 3.75 per cent to 4.75 per cent by the end of July 2027. Some expectations point to a further increase to 5 per cent by December 2027. But several economists believe that forecast may overstate how aggressively the Bank will need to respond to rising prices.
The disagreement matters for households and businesses because interest rate expectations influence borrowing costs, including mortgage pricing, loans and the cost of financing business investment. If rates rise less than markets anticipate, borrowers could face a different financial outlook from the one implied by current market pricing.
The immediate concern is inflation. UK inflation rose to 3.5 per cent in September, above the Bank's 2 per cent target, amid higher fuel costs linked to tensions in the Middle East. The Bank is widely expected to raise rates to 4 per cent at its November 5 meeting, although the path beyond that remains uncertain.
James Smith, a developed markets economist at ING, said traders were pricing in four increases followed by no cuts, a scenario he believes few forecasters would support.
“By next spring, I think they [the Bank] could be sounding the all clear, and by the end of next year they could be cutting rates again,” Smith reportedly said at a briefing in the City last week.
Why do markets expect UK interest rates to reach 5 per cent?
The rise in energy prices is a major factor behind the more aggressive forecasts. Since the Iran war began, market expectations for interest rates have moved closely with oil prices, as traders weigh the risk that higher energy costs will feed into wider inflation.
But market pricing does not necessarily represent economists' most likely forecast. It is derived from financial instruments, including interest rate swaps, which allow investors to manage or take positions on where borrowing costs may move. The prices also reflect the risks investors are prepared to take and the compensation they demand for uncertainty.
Smith said traders who bet against further rate rises could face losses if oil prices continued to climb, even if they ultimately proved right about the Bank's decisions. Some investors may therefore be reluctant to challenge the market consensus until there is greater clarity about energy supplies and inflation over the winter.
Sanjay Raja, chief UK economist at Deutsche Bank, also questioned whether rates would rise as far as markets suggest.
“I do not believe that any mainstream forecaster thinks the Bank of England will hike to 5% by the end of next year with the information set we have today,” Raja reportedly said. He added that the outcome was not impossible, but appeared less likely based on current projections.
Deutsche Bank estimates that part of the expected increase reflects what economists call “risk premia”. In simple terms, these are extra returns investors demand to compensate for uncertainty. Once that element is stripped out, the bank estimates that only around half a percentage point of rate rises is priced in.
Its central forecast is for the Bank to raise the base rate to 4.25 per cent by February and hold it there until the end of 2027.
How much could UK interest rates actually rise?
Other forecasters also expect a more limited increase than financial markets currently imply, although their projections differ.
Oxford Economics expects the Bank's Monetary Policy Committee to raise rates by a quarter of a percentage point at its November and February meetings, taking the base rate to 4.25 per cent. It sees this as significantly below the market's projected peak of between 4.75 per cent and 5 per cent.
Goldman Sachs has also said its probability-weighted forecast remains below market pricing, while still expecting a rise to 4 per cent in November. Morgan Stanley's central scenario similarly includes increases in November and February, followed by a period in which rates remain unchanged.
There are risks to that more moderate outlook. Morgan Stanley has pointed to the possibility of additional pressure if the Low Pay Commission recommends a larger-than-expected increase in the national living wage. Higher wage costs could add to inflationary pressure, depending on how businesses respond.
Even Huw Pill, the Bank of England's chief economist, has expressed scepticism about market expectations of four rate rises over the next year.
For borrowers, the distinction is important, but it does not guarantee cheaper mortgages or a return to lower rates. Lenders can adjust mortgage pricing ahead of official Bank decisions, and the eventual path will depend on inflation, energy prices, wage growth and the wider economic outlook.
The November meeting should provide the next indication of how policymakers assess those pressures. Beyond that, the gap between market pricing and economists' forecasts is likely to narrow or widen as new data emerges. For now, a rate of 5 per cent remains a market-implied possibility rather than a settled outcome.
