UK confidence crisis could necessitate an emergency BoE hike

Markets are now pricing in Bank Rate reaching nearly 6% by the middle of next year, almost 400bp above current levels. Markets have also priced in some probability of an inter-meeting emergency hike, although that probability has declined following a statement yesterday by the Bank of England. As things stand, the government looks to be in no hurry to perform a U-turn on its unfunded plans to massively cut taxes (notwithstanding signs of discontent among backbench MPs), with a Truss government advisor quoted in the FT this morning as saying that Chancellor Kwarteng only needs to explain his approach to markets better, and that higher rates are a good thing because ‘we need to move away from cheap money.’ This suggests that the responsibility for crisis fighting lies squarely with the Bank of England for now, making aggressive rate hikes potentially unavoidable.

Such aggressive rate hikes could be disastrous for the economy

Initially, our take from the mini budget on Friday was that it would merely delay the pain about to hit the economy, rather than avoid it. Now, with such a steep rise in interest rates potentially on the cards, the budget is not even likely to delay the pain. If the BoE really does follow through on current pricing to hike Bank Rate to 6% over the coming months, it could plunge the economy into a deep recession already next year. Business investment would become prohibitively expensive, and households are highly exposed to rising interest rates given that mortgages in the UK are typically only fixed at relatively short time horizons. 25% of mortgages are immediately exposed as they are on variable rates, while half of the remaining mortgages on a fixed rate are due to expire in the next two years. Mortgage rates rising potentially north of 7% would therefore represent a massive income shock to UK households, coming on top of the already large shock from energy prices.