1 in 3 chance interest rates will hit 5.75%: Stark warning for households

Interest rates have a nearly one-in-three chance of climbing to as high as 5.75 per cent this year as the Bank of England is forced to step up its fight against inflation.

Financial markets are increasingly betting that rates have much further to go after figures this week showed the battle to keep a lid on prices was proving harder than expected.

And the Bank of England was yesterday given political cover to keep raising the rates after Chancellor of the Exchequer Jeremy Hunt said that he was ‘comfortable’ for rate-setters to do what it takes, even at the risk of provoking a recession.

Interest rate expectations have taken a big step up over recent days.

Before this week’s inflation figures were published there were hopes that they had little further to go after hitting 4.5 per cent earlier this month.

Now, markets are betting they will reach 5.5 per cent by the end of the year – and are pricing in a chance of around 30 per cent that they will hit 5.75 per cent.

Rates are expected to fall from the start of next year.

But they still look set to remain above 5 per cent well into 2024, meaning that borrowers will still be feeling the squeeze as a likely General Election nears.

The step-up in rate expectations comes after the Office for National Statistics (ONS) said that the consumer price index (CPI) of inflation dipped to 8.7 per cent last month.

It was the first time that the CPI has dropped below 10 per cent since last summer.

But the figure was still far higher than expected.

The data was described as ‘a shocker’ by economists at the HSBC bank.

They lifted their expectations for the Bank rate to 5.25 per cent but said: ‘We still think the risks are tilted towards rates needing to go even higher this year.’ While the headline rate has fallen, ‘core’ inflation – stripping out volatile items such as food and energy – is up from 6.2 per cent to 6.8 per cent, its highest in more than 30 years.

Rising core inflation is a worry for the Bank because it suggests spiralling prices are becoming ingrained in the economy, even after the initial shock caused by the war in Ukraine has started to fade.

The figures shook markets this week, pushing up the ‘swap’ rates used to price mortgage products and driving UK bond yields to levels not seen since last autumn’s mini-Budget crisis.

Nationwide, Britain’s biggest building society, put up rates on some mortgage deals by 0.45 percentage points. Experts said rivals were likely to follow suit.

But a source at one major bank which has not increased its rates played down the volatility, saying: ‘Markets can overreact when we see unexpected data and that may be what we are seeing now.

‘Base rate often doesn’t then follow the path that the markets expect through the swap rates.’

Even before this week’s data there were fears about how long it would take to defeat inflation.

Bank of England forecasts this month suggested it would take nine months longer than previously thought for CPI to fall to its 2 per cent target.

It now expects inflation will still be above 5 per cent by the end of this year, meaning Prime Minister Rishi Sunak would only just meet his target of halving it.

Last week, Bank Governor Andrew Bailey admitted that the wage and price spiral unleashed by the initial inflation spike could take longer to bottle up than it did to emerge.

Bailey warned that inflation could remain high, reflecting ‘the possibility of more persistence in domestic wage and price setting’.