The shift in expectations in the swap market — which sees rates at 4% in May compared to 1.75% today — is among the biggest swings in years. The shift in expectations, fueled by persistent increases in forecast inflation and rising energy prices, is being reflected in other markets. In the UK bullion market the cost of two-year borrowing for the government has risen more than 1 percentage point this month, marking the biggest rise in Bloomberg records dating back to 1992. Market moves will be reflected in the cost of corporate borrowing and fixed-rate mortgage deals, affecting companies and households even before the BoE makes interest rate decisions in the coming months. Higher borrowing costs will further weigh on UK economic activity and the finances of households and businesses already suffering from high energy, fuel and food prices – although City economists expect a smaller rate rise. Traders in the overnight index swap market, which sets prices based on expectations of future policy rates, are now betting that rates will rise to 2.75 percent by the BoE meeting in November before reaching 4 percent in May. Separately, the two-year government bond yield – which indicates the average interest rate over the next 24 months – is now trading at 2.94 percent, compared with 1.83 percent just a month ago. “It’s been a one-way move since the beginning of August,” Matthew Russell, director of fixed income funds at M&G Investments, said of gold’s moves. “The moves were oversized.” Traders have been worried as UK inflation has topped expectations almost every month this year, rising to 10.1% in July. Russell said Citigroup’s forecast that UK inflation would hit 18.6% next year “brought a lot of attention back to [short duration] the gold market and this combined with the situation in the energy markets in Europe, plus the thin liquidity of the summer in the markets, is responsible for the sharp rise in gold [yields]”. With energy prices continuing to weigh on inflation, the new retail gas and electricity price cap for October to December will be announced on Friday. Analysts expect Ofgem, the industry regulator, to increase annual energy costs for an average household from £1,971 to more than £3,500. Traders in government bond and interest rate futures markets pushed interest rate expectations higher on any bad news about inflation. Craig Inches, head of rates and cash at Royal London Asset Management, said the prediction that the BoE would raise rates to 4% was reasonable. “I just don’t see a situation in the near term where inflationary pressures are going to ease,” he said. Financial markets’ forecasts for interest rates reflected the central bank’s comments that it would be willing to act “aggressively” if it felt inflation had been embedded in corporate and household expectations. Economists are much less willing to bet on the BoE being so aggressive with monetary tightening. The consensus among City economists is that interest rates will peak at 2.5%, but expectations are changing.

Paul Dales, chief UK economist at Capital Economics, which expects interest rates to reach 3%, said market expectations had “jumped” in recent weeks. “At this stage I wouldn’t really want to rule anything out,” Dales said. He added that while 4 percent interest rates were not “completely out of the question anymore . . . History shows that markets tend to exaggerate the extent of tightening cycles. So right now I think the markets are a little bit off.”