UK Gilt Yields Explode Higher On Surprise BoE Rate-Hike Threat

The Bank of England shocked markets this morning, signaling that it is prepared to raise rates to counter a pickup in inflation driven by the conflict in the Middle East.

Specifically,t he BoE said it would act to counter the pickup in inflation if it threatened to become persistent, but faced high levels of uncertainty about the outlook and would seek greater clarity before deciding on the path for interest rates.

"I will be monitoring developments extremely closely and stand ready to act as necessary to ensure inflation remains on track to meet the 2% target," said Gov. Andrew Bailey.

Before attacks on Iran by the U.S. and Israel began late last month, the U.K.'s central bank had been expected to lower borrowing costs at this week's meeting of its policymakers.

However, the conflict has sent energy prices surging, while its impact on fertilizer costs is likely to see a revival of food inflation.

Instead of cutting, the BoE left its key interest rate at 3.75%, a reflection of how the conflict has changed the outlook for economies around the world.

In doing so, the BoE matched the Federal Reserve's decision Wednesday. The Bank of Canada and the Bank of Japan have made the same call, as have the central banks of Sweden and Switzerland earlier Thursday. The European Central Bank is soon expected to follow suit later Thursday.

Ahead of today, there had been expectations that there could still be dovish dissent on the MPC. The 9-0 vote in favour of unchanged rates has rebuffed such expectations. 

The response to the 'hawkish hold' was dramatic with 2Y Gilt yields exploding 30bps higher...

For context, that is highest 2Y Yield since Jan 2025 with yields up a stunning 90bps since the war began!

As The Wall Street Journal writes, for the BOE, as for other central banks, the key question is how long the period of higher energy costs will last, and what impact it will have on the prices of other goods and services.

Officials at the U.K.'s central bank have been chastened by their experience in 2022, when a surge in energy and food prices following Russia's full-scale invasion of Ukraine led to a jump in wage demands, and higher prices for a range of labor-intensive services.

As a result, inflation stayed above their target for longer than they had expected.