Data Dovish, Market Hawkish: Bank of England Faces Policy Signal Test on Thursday

Interest rate futures are firmly betting on a Bank of England rate hike in November.

The Bank of England will announce its interest rate decision, meeting minutes, and latest economic forecasts on Thursday, followed by a press conference from Governor Bailey. Most economists surveyed by Reuters expect the Monetary Policy Committee (MPC) to keep rates unchanged with a 7-2 vote, holding steady throughout the year.

Previously, UK June CPI dropped to a 15-month low, and private sector wage growth hit its weakest level since 2020. The government led by new Prime Minister Andy Burnham has listed tackling the cost-of-living crisis as its top priority, announcing the removal of VAT on household electricity bills.

UBS economist Anna Titareva calculated that this move would exert downward pressure of about 0.1 percentage points on inflation. Titareva explicitly bets on rate cuts:

The next policy move will be rate cuts, in February and April 2027.

Although there is hardly any fundamental logic supporting a Bank of England rate hike, Wednesday's interest rate futures data points to a 25 basis point hike by the Bank of England in November, followed by another hike in March 2027.

This meeting coincides with the Federal Reserve's July decision, which shook the market with three dissenting votes for a rate hike. Chair Walsh expressed a "zero tolerance" attitude towards inflation, and the global hawkish cloud has narrowed the Bank of England's decision-making window.

CPI and Wages Weaken in Tandem, Fiscal Relief Intensifies

The simultaneous decline in domestic prices and labor costs in the UK forms the core support for the Bank of England to hold rates steady.

June CPI fell to 2.6%, a 15-month low; as a sticky indicator closely watched by the central bank, private sector wage growth slipped to 2.9%, the lowest since 2020, indicating that the risk of an overheated labor market continues to recede.

Fiscal coordination has further widened the policy space. The removal of VAT on household electricity bills is a key cost-of-living measure pushed by the Burnham government since taking office.

On this basis, the Bank of England has already lowered its inflation peak expectation for this year from 3.6%-3.7% in April to slightly above 3.25% under two of the three scenario assumptions regarding energy prices and inflation persistence.

However, UK inflation has remained above the central bank's 2% target for most of the past five years. The UK Monetary Policy Committee is closely monitoring whether the 2027 pay negotiations starting later this year will reignite wage demands.

Most committee members currently judge that, against the backdrop of a weak labor market, the current interest rate level is sufficient to drive inflation down gradually.

Clash Between Economist Consensus and Futures Pricing

A Reuters survey shows that most economists expect the UK Monetary Policy Committee to keep the benchmark interest rate unchanged at 3.75% with a 7-2 vote, with no adjustments for the rest of the year.

However, the interest rate futures market presents a completely opposite picture. It not only completely rules out the possibility of a rate cut within the year but also prices in a 25 basis point hike in November and another hike in March 2027.

The core logic driving this bet comes from energy prices— the Strait of Hormuz has been closed for five months. Although current oil price futures remain at the lower end of the Bank of England's scenario assumptions, the pulse-like surge breaking through $100 per barrel last week still triggered market alertness to an inflation rebound.

Divergence within the UK Monetary Policy Committee is also deepening. Chief Economist Huw Pill and external member Megan Greene are expected to continue voting for a rate hike, while Deputy Governor Clare Lombardelli and external member Catherine Mann are considered most likely to join them. Mann warned this month that falling market borrowing costs could make inflation control more difficult.

Matthew Ryan, Head of Market Strategy at financial services company Ebury, pointed out:

Current oil price levels and recent economic data do not support the Bank of England rushing into a rate hike or sending overly hawkish communication signals.

Most members of the UK Monetary Policy Committee believe that the overall tightening of financial conditions since the Middle East conflict has effectively substituted for part of the tightening function.

Oil Price Variables and Fed Hawkish Spillover

Wall Street Insights mentioned that the Federal Reserve kept interest rates unchanged at its July meeting, while three FOMC members favored a 25 basis point hike. This internal divergence adds new uncertainty to the global monetary policy path.

Bailey previously stated that the signal to pause rate cuts released by the Bank of England in March was "promising" for controlling inflation. This tentative tone actually retains flexibility for the policy path.

In terms of the Bank of England's own operations, the pace of quantitative tightening slowed from £100 billion annually to £70 billion in 2025. Financial market participants expect the UK Monetary Policy Committee may further reduce the balance sheet reduction speed to £50 billion in September.

The foundation of UK inflation is more fragile compared to the Eurozone. Energy prices have a higher transmission weight in the CPI basket, and the wage stickiness in the labor market has not yet been cleared.

In this context, even if the decision on Thursday is highly likely to remain unchanged, the market's pricing of a rate hike itself constitutes a form of implicit tightening. Bailey's wording at the press conference will be a key signal testing the central bank's attitude towards current market pricing.