UBS has revised its outlook for the Bank of England, now forecasting two additional interest rate hikes after the central bank adopted a more hawkish tone at its latest policy meeting.
The bank expects two 25-basis-point increases, one in November 2026 and another in February 2027. That would lift the Bank Rate from 3.75% to 4.25%.
Bank of England Holds Rates at 3.75%
The Bank of England kept interest rates unchanged at 3.75% on Thursday.
The decision was approved by a 6-3 vote, matching the split recorded at the previous meeting in July.
However, UBS said the Monetary Policy Committee delivered a noticeably more hawkish message than before.
According to the bank, policymakers have become increasingly concerned about upside risks to inflation. The MPC also sees a greater chance that higher prices could trigger stronger second-round effects across wages and the broader economy.
These concerns were shared by the six members who voted to keep interest rates unchanged.
UBS Reverses Previous BoE Rate Forecast
UBS had previously expected the Bank of England’s next policy move to be a rate cut.
Its earlier forecast called for reductions in February and April 2027. However, the latest BoE communication has prompted the bank to reverse that view.
UBS now expects the Bank Rate to peak at 4.25%, around 75 to 100 basis points above what it considers the neutral interest rate.
Despite this change, UBS does not believe the expected increases will mark the beginning of a prolonged tightening cycle.
Instead, the bank described them as “adjustment” hikes designed to demonstrate that policymakers are responding proactively to inflation risks.
BoE Could Begin Cutting Rates in Late 2027
After rates reach an expected peak of 4.25%, UBS believes the Bank of England could begin easing monetary policy during the fourth quarter of 2027.
It expects the MPC to cut rates roughly once per quarter after that.
Under the forecast, the Bank Rate would gradually decline to around 3.25% by the third quarter of 2028.
Middle East Conflict Adds to Inflation Risks
Bank of England Governor Andrew Bailey also highlighted the potential impact of geopolitical tensions on monetary policy.
Bailey indicated that policy may need to become tighter if the conflict in the Middle East continues for an extended period and increases the risk of secondary inflation effects.
Energy prices have therefore become an important part of the BoE outlook.
The MPC noted that current spot energy prices are close to levels assumed under the adverse scenario published in July. That scenario suggested tighter monetary policy could be required to return inflation to target.
However, energy futures remain below those levels, leaving some uncertainty around the longer-term inflation outlook.
Bank of England Plans Further Gilt Unwinding
The Bank of England also announced a multi-year strategy for reducing its remaining holdings of UK government bonds.
The central bank is targeting an average annual reduction of £46 billion. This would include around £20 billion in active gilt sales each year.
Bonds maturing before 2035 will be allowed to run off naturally.
Meanwhile, gilts with maturities between 2049 and 2071 are expected to be held until redemption.
The BoE also aims to sell around £20 billion per year of bonds maturing between 2035 and 2049 to the UK Debt Management Office rather than directly into the market. The plan remains subject to final agreement with the Treasury.
Further operational details are expected by April 2027.
UBS Maintains Bullish Gilt Yield Forecast
UBS continues to forecast that the UK 10-year gilt yield will reach 5.25% by the end of the year.
The bank also favors receiving SONIA 1y1y against 6m1y.
Its view is based on the expectation that the Bank of England could become more willing to reduce interest rates once energy prices start to decline.
UBS Expects Near-Term Pound Weakness
UBS also remains cautious on the British pound in the near term.
The bank sees scope for EUR/GBP to move toward 0.8650 ahead of the Autumn Budget, largely because of uncertainty surrounding UK fiscal policy.
UBS noted that fiscal headroom has deteriorated significantly, with higher bond yields playing an important role.
Despite this near-term outlook, the bank continues to target EUR/GBP at 0.8500 by the end of the year.
Markets Price More Tightening Than UBS Expects
UBS also highlighted a significant gap between its forecast and current market expectations.
Financial markets are pricing in close to 100 basis points of monetary tightening over the next 12 months.
UBS considers that outlook considerably more hawkish than its own forecast, suggesting that investors may be expecting a more aggressive Bank of England tightening path than the bank currently anticipates.
