The City is bracing for a sharp rise in UK interest rates on Thursday, and further hikes by the end of the year.
Financial markets are betting there is a 75% chance that the Bank of England will increase rates to 2.5% this week, up from 1.75% at present – a 0.75% rise.
That would be the biggest rate hike since 1989, when inflation was climbing rapidly after a consumer boom. It also follows six rises from the UK central bank already this year.
Money markets have priced in 200 basis points of hikes over the next three decisions, implying Threadneedle Street will raise rates by three-quarter points at two of those meetings.
They are also predicting that rates could reach 3.75% by the end of the year, while the UK central bank is also due to start quantitative tightening.
“The arguments for a 75 basis-point move are more compelling than those for a 50 basis-point increase,” Paul Hollingsworth, chief European economist at BNP Paribas, wrote in a note to clients.
However, a survey by Bloomberg gave a less bullish result. The majority of the 47 economists it surveyed expect the Bank to raise its benchmark lending rate by a half-percentage to 2.25%.
The members of the monetary policy committee (MPC) are likely to split on the decision.
Matthew Ryan, head of market strategy at global financial services firm Ebury, said: “We think that the decision between a 50bp and 75bp rate hike will be a close call among BoE members at this Thursday’s meeting…”
“Traders will be paying very keen attention to the MPC’s communications after the decision, particularly comments on how high rates could go in 2023.”
Watch: How does inflation affect interest rates?
It comes as inflation is almost five times above the Bank’s 2% target, at 9.9%, with forecasts set to rise further.
According to the Office for National Statistics (ONS) earlier this month, the UK’s rate of inflation eased in August after registering a double digit increase for the first time in more than four decades the month before.
This was below economists’ expectations, however core prices, which exclude volatile items like energy and food, ticked up to 6.3% from 6.2%, suggesting price rises are firmly embedded across the economy.
The pound’s (GBPUSD=X) tumble to its lowest level since March 1985 today has also added to the pressure to hike UK interest rates.
“After the pound slumped to a 37-year low the market is pricing in an aggressive 75 basis point hike from the Bank of England as it looks to get a grip on near 10% inflation,” Victoria Scholar, head of investment at Interactive Investor, said.
“Pressure from sharp central bank rate increases around the world are encouraging the Bank of England to keep up. The central bank may also be feeling the pressure to act more forcefully in light of the recent slump in the pound.”
It comes after the European Central Bank (ECB) raised interest rates by 0.75 percentage points this month for the first time since the launch of the euro. It has come under continued criticism for being behind the curve and acting too slowly on inflation.
Meanwhile, Sweden's central bank raised interest rates on Tuesday by a larger-than-expected full percentage point, and the US Federal Reserve is set to announce another 0.75% rise this evening.
Samuel Tombs at Pantheon Macroeconomics said: “The MPC is boxed into a corner right now and might raise the bank rate quickly to prevent sterling from depreciating further, and to signal to households that it is serious about tackling inflation.”
It comes amid a warning that UK households would face a £3.1bn hit in extra mortgage costs if the BoE goes ahead with the 0.75% rate rise.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: “For anyone who is already struggling with runaway price rises, the extra cost of the mortgage could be the final straw.
“While anyone with a fixed rate is currently protected, all these rate rises will be adding up and hit them in one fell swoop when it’s time to remortgage.
“If you have less than six months left to run on your mortgage deal, it makes sense to lock in a new fixed rate as soon as possible, ahead of potential rate rises.”
Watch: Will UK house prices ever fall?