British households have been warned that interest rates could rise as many as five times in little over a year to tame rampant inflation.

As fears mount of a fresh energy price shock this winter, investors are betting that rates will jump from the current rate of 3.75 per cent to 5 per cent by November next year.

Many economists do not believe rates will rise by anything like this amount – offering some hope for borrowers already facing punishing rises in mortgage costs.

Some even believe rates will not rise at all this year and could start being cut in 2027.

Pressure mounted on the Bank of England to move at least once, as the US Federal Reserve raised interest rates tonight for the first time since 2023, with a unanimous 12-0 vote. 

Kallum Pickering, chief economist at Peel Hunt, said: ‘I can seldom remember a time when my own view on the likely path for Bank of England monetary policy has differed so much from that of money markets. I see the Bank holding for the rest of this year before cutting twice next year once inflation risks fade.’ 

But that is not the view on financial markets, where the chances of a rate hike as soon as Thursday this week are put at 35 per cent.

That follows official inflation figures that on Wednesday showed the consumer prices index well above the 2 per cent target at 3.1 per cent in August. 

The prospect of interest rate hikes is wreaking havoc on global bond markets with UK borrowing costs hitting their highest levels since 1998.

Even if the Bank of England does hold off this week, there is an 80 per cent chance of a hike following the next meeting of the monetary policy committee on November 5.

That would spell misery for households with mortgages and other borrowers including businesses just days after Chancellor John Healey's first Budget on October 28.

It means there is a good chance Britons will go into Christmas facing higher taxes and borrowing costs as well as sharp increases in everything from fuel and energy bills to food as conflict in the Middle East drives up oil and gas prices.

> Food prices to soar for two years and energy prices forecast to jump 25%

Oil came close to $110 a barrel this week as the war fuels fears over supplies.

That has pushed up prices at the petrol pumps to a four-year high – hitting motorists in the pocket.

Energy bills look set to follow suit with forecasts by Bloomberg Economics warning of a £427 or 25 per cent rise in January to £2,150 a year for a typical household.

That could push inflation above 4 per cent next year – ramping up pressure on the Bank of England to hike rates.

Anthony Brinkman, high yield portfolio manager at Principal Asset Management, said: ‘The recent gilt market movements seem to be intent on showing central banks they are out of time – the market is expecting action.’

But many economists believe the financial markets have gone too far in betting on as many as five rate hikes in the UK in little more than a year.

Martin Beck, chief economist at WPI Strategy, said: ‘I don’t think we’ll see any rate rises.

‘Financial markets and economists are looking at the same thing differently. Markets are pricing the distribution of risks. At present they're putting a lot of weight on the possibility of another inflation episode, a more hawkish Bank and the risk that policymakers decide they must act pre-emptively.

‘Economists, by contrast, are generally forecasting what they regard as the most likely outcome. Hence the much smaller number of expected increases.’ 

He added: ‘We continue to think the next move in rates will be down rather than up, most likely in early 2027.’

At the heart of the issue are what economists and central bankers call ‘second-round effects’.

This is what happens when an initial price shock – on this occasion the spike in energy bills driven by the surge in oil and gas prices due to the Iran war – feeds through into price rises more generally and higher wages.

Some economists argue that while prices of certain goods have increased – including, importantly, food – there is little evidence of an increase in wages that could then lead to yet more price rises and leave inflation deeply embedded in the economy.

‘Rate rises cannot produce barrels of oil,' said Pickering at Peel Hunt. 

'With second-round effects so far subdued, the lesser evil would be for the Bank to tolerate a temporary overshoot rather than inflict further damage on an already weak economy.

'Hiking as energy prices push inflation higher over the coming months should only happen if genuine evidence of serious second-round inflation effects emerges in the domestic economy.' 

Official figures this week showed average pay growth of 3.9 per cent over the past year – the weakest since November 2020 during the Covid-19 pandemic.

It was particularly subdued in the private sector, where earnings were up just 2.9 per cent, while the public sector saw pay jump 6.3 per cent.

With employers shedding 101,000 jobs in the past year, and vacancies at the lowest level for 12 years outside the pandemic, workers appear to have little negotiating power when asking for pay rises to cover higher living costs – easing inflation fears.

Suren Thiru, chief economist at accountancy body ICAEW, said ‘a cooling jobs market is currently the last line of defence against a rate hike’.

He said: ‘The UK labour market remains locked in a low-hire, low-fire funk, as sky-high labour costs, the continued fallout from US-Iran tensions and domestic policy uncertainty encourage firms to tread more cautiously on hiring and pay.

‘Weak wage growth suggests that elevated employment costs and softer hiring demand are holding back pay rises.

‘The ongoing drop in vacancies should set alarm bells ringing for the jobs market, as it suggests that demand for workers is wilting under the weight of soaring staffing costs, onerous regulation and increased automation.’

Beck believes expectations of multiple rate hikes ‘place too much weight on second-round effects that have repeatedly failed to materialise’.

He said: ‘Contrary to expectations, against the big energy shock earlier this year, UK inflation didn't jump as predicted. That suggests caution about assuming it will happen now, particularly with wage growth slowing, the labour market deteriorating, services inflation easing and competition limiting businesses ability to generate the self-reinforcing price-wage spiral policymakers are worried about.

‘Unless there is a genuinely new shock, rather than simply the delayed consequences of the existing one, I see very little in the domestic UK data that requires higher interest rates.’

Philip Shaw, an economist at Investec, said: ‘The key is that the labour market remains loose, implying that higher inflation will not be passed onto higher pay, reducing the risk of inflation persistence in the economy.

‘Although we still judge that rate hikes will be avoided, it is possible that with inflation having almost continuously exceeded the 2 per cent target for five years, that the Bank opts for precautionary increases. These could be reversed if inflation comes back down quickly.

‘But four to five hikes look excessive. UK (and other) interest rate markets are very nervous given the geopolitical situation and appear to be pricing in a safety margin on borrowing costs.’