Will interest rates rise next week?

The Bank of England is tipped to hike interest rates next week, but by how much will borrowing costs go up in the coming months?

Markets now appear certain that UK interest rates will rise for the first time in more than three years when Bank of England policymakers meet on Thursday next week.

The Bank's base rate has been at 0.1% since two quick-fire cuts from 0.75% were made in March 2020 to support the economy at the outset of the pandemic.

But the economic recovery has been quicker than expected, as signalled by chancellor Rishi Sunak yesterday after the Office for Budget Responsibility (OBR) forecast growth of 6.5% this year up from the 4% projected in March.

Sunak also admitted that inflation was the biggest threat to his plans after noting that the consumer prices index (CPI) is set to average 4% over the next year.

The desire to stop inflationary expectations becoming entrenched means the Bank's monetary policy committee (MPC) is tipped to act sooner rather than later on rates.

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As a result, markets are now pricing in a 100% probability of a rise to 0.25% next week, even though the first unemployment data since the end of the furlough scheme won't have been published at that point. It was only a few weeks ago that many economists had suggested May next year as the most likely starting point for policy tightening.

The rate rise, which is likely to be accompanied by a halt to quantitative easing, is expected to be followed by a second hike of 0.25% to 0.5% by February as policymakers adopt a strategy of making earlier but fewer hikes.

They will be hoping to avoid the OBR's worst-case scenario where interest rates have to rise to 3.5% if inflation surges above 5%. The Bank's base rate was last that high in 2008.

Capital Economics said today that there were compelling reasons to think interest rates will be raised at the November meeting.

Chief UK economist Paul Dales said: “Since the MPC doesn’t tend to surprise markets, if members thought a rate hike in November was unlikely then we would have expected them to push back against investors’ expectations by now.

“And to the extent that the MPC wants to raise interest rates to stop inflation expectations from rising further, then it may make sense to do that sooner rather than later.” 

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Dales thinks that markets have gone too far by pricing in a total of five rate hikes to 1.25% by the end of 2022, compared to the 1% seen prior to yesterday's Budget. He added that the MPC will be fearful of tightening too far too soon, which is what the European Central Bank did in 2011.

The rate rises are likely to be beneficial for the profitability of Lloyds Banking Group (LSE:LLOY) and Britain's other lenders, particularly at a time when there are few worries about asset quality or the threat posed by unemployment.

However, there's only small comfort for savers as the huge gulf between the inflation rate and the account rates on offer on the high street is set to remain for a lot longer.