Those keeping an eye on UK interest rate expectations during the past year have had a bumpy ride.
Coming into 2026, the prevailing view was that rates would be cut as the inflationary pressures of 2022 finally receded, only for the conflict in Iran to upend the benign scenarios and send the market into sharp revision mode.
The extent of a divergence of opinion can be seen from the fact that while the market is pricing in one rate rise this year and two next, at the most recent meeting of the Bank of England’s Monetary Policy Committee the vote was 7-2 in favour of retaining the status quo.
To further muddy the waters, the European Central Bank recently put up rates, while the US — where the economic data is continually robust — has backed away from the previous bias to easing, causing investors to reconsider the impact on US assets.
Policymakers generally begin their deliberations by asking whether current rates are restrictive or accommodative.
Restrictive rates are those that are too high, and so limit the potential growth rate of the economy rather than simply restrain inflation.
Accommodative rates are the opposite, being low enough to help stimulate economic growth.
Between the two extremes is r*, the neutral rate of interest, which is neither too low to create inflation nor too high to restrict growth.
Policymakers are not usually trying to set rates at the neutral level, rather they will seek to be either restrictive or accommodative in order to aide economic goals.
There is no doubt, says Nicolas Trindade, senior portfolio manager for fixed income at BNP Paribas Asset Management, that UK monetary policy is presently in restrictive territory.
But he says he does not want or expect rates to rise any time soon.
That is because, in addition to considering the health of the present economy, they must also ponder the economic signals being sent, and what those reveal about the future direction of the economy.
Trindade’s view is that two factors mean the BoE will in time move from restrictive to accommodative — that is cut rates — but not yet.
The not yet is because, he says, the Bank has to be certain the Iran conflict has come to an end and oil prices will drop.
The second reason he says rates will fall in the UK is due to the effects of higher energy prices on inflation not having yet fed through into the wider economy.
2022 all over again
The immediate thought of many market participants when the gulf conflict began was of economic conditions resembling the situation in 2022, when Russia’s invasion of Ukraine sparked an energy price shock, which then percolated into the wider economy, leading to higher headline inflation and wage growth in the economy.
But Hetal Mehta, chief economist at St James’s Place, says the major difference this time is labour market conditions are much weaker, meaning the spiral of the energy price shock into the wider economy is much less likely to happen.
Her view is that the current base rate in the UK is in “restrictive” territory, that is: too high relative to the prevailing outlook for inflation and economic growth.
