Political turmoil is driving up UK borrowing costs as investors start to price even higher interest rates, on expectations of looser fiscal policy. Yet the case for rate rises is far from clear-cut. We expect a one-and-done hike in June
Political Drama Is Once Again Driving Up UK Borrowing Costs
Financial markets have responded to renewed UK political turmoil by ramping up bets on Bank of England tightening. We warned that what ultimately became disastrous local elections for the ruling Labour Party left markets exposed to a sell-off amid renewed leadership speculation.
Almost three rate hikes are priced before year-end, almost identical to what’s expected from the European Central Bank.
We remain unconvinced. We’re now forecasting one rate hike from the BoE in June, but only narrowly. At April’s meeting, officials made clear that simply not cutting rates – something the Bank would likely have done at least twice this year absent the Iran war – already amounted to de facto tightening. With energy prices not far from today’s levels, the prevailing view inside the Bank felt somewhere between a prolonged hold and a one-and-done rate hike.
We’re nudging towards the latter, largely because our own energy assumptions are more aggressive than the low and central scenarios officials were considering late last month. Even so, the case for a multi‑hike cycle looks thin.
Though Prime Minister Keir Starmer is fighting on, investors are increasingly pricing a leadership contest that leaves Labour shifting left, loosening fiscal rules and increasing borrowing. In theory, that could argue for higher interest rates. In practice, memories of the 2022 mini‑budget crisis remain raw, and any leadership hopeful will be under intense pressure to rule out dramatic fiscal changes.
Even if they don’t, meaningful policy shifts are unlikely before the Autumn Budget, probably in November. The Bank of England cannot respond to fiscal changes that have not been formally announced, meaning leadership speculation is unlikely to matter for monetary policy before the fourth quarter – if at all.
UK Interest Rate Expectations Have Risen Further Than Elsewhere
Source: Macrobond, ING
The UK Isn’t More Exposed Than the Eurozone to Inflation
The wider macro case for higher interest rates is also far from clear-cut – and certainly less so than in the eurozone. UK policy rates are at more restrictive levels already. The jobs market is comparatively weaker, looking at vacancies, and the energy spike is likely to add extra pressure on unemployment. And don’t be fooled by a spike in first-quarter , which we think was overwhelmingly driven by problems with seasonal adjustment. Taken together, the risk of second‑round inflation effects shouldn’t be overstated.
Finally, claims that the UK is uniquely exposed to energy shocks are only half right. Britain is highly reliant on – around 32% of total energy consumption, versus 20% in Germany and 15% in France. But this is not, yet, a gas crisis. On net energy imports, the UK compares favourably with much of Europe.
That is why our outlook remains remarkably similar to the eurozone’s. We expect CPI to peak a touch above 4% in the second half of the year.
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