BofA expects two Bank of England hikes amid energy pressures

Bank of America now expects the Bank of England to raise rates twice in 2026, in July and September, before cutting three times starting in Q2 2027 to 3.5%. The firm said elevated energy prices, inflation pass-through, and second-round effects argue for continued tightening, but a U.S.-Iran peace deal could reduce oil prices and raise the risk of fewer or delayed hikes. The timing risk is centered on September, when the MPC will have July inflation data after the Ofgem price-cap reset.

Analysis

The key second-order issue is not whether the BoE hikes twice, but whether it preserves the term-premium signal already embedded in the front end. If policymakers wait too long, the market will do part of the easing for them by repricing the whole path lower, which is effectively a stealth rate cut before any official move. That makes the September window more powerful than July: it coincides with fresher inflation evidence and avoids validating premature easing in rates markets.

A durable drop in oil from geopolitics would matter less through headline CPI and more through wage-bargaining and inflation expectations. The real transmission risk is that households and firms treat cheaper energy as a one-off while core services stay sticky, which would leave the BoE facing a credibility tradeoff: tolerate a temporary overshoot or tighten into softer growth. Conversely, a material labor-market deterioration would shift the regime from “restrictive but patient” to “look-through and cut,” which would steepen the front end quickly and compress UK rate-vol-sensitive assets.

The more interesting market expression is in GBP duration rather than outright sterling. If the curve continues to price out hikes, bank equities and domestic cyclicals can underperform even without an immediate recession because net interest margin support fades while credit risk lags. The best contrarian setup is that the market may be underestimating how much of the inflation scare is already in energy-linked components; if peace expectations hold and gas/liquid fuel prices roll over, the BoE may end up with room to delay hikes without ever needing to deliver them.

Key Decisions for Investors

• Short SONIA front-end futures into the July BoE window; target a 20-35bp repricing lower in hike probability if incoming inflation/data soften, with stop-loss if energy prices re-accelerate or wage prints surprise high.
• Long UK gilts in the 2-5Y bucket versus short GBP/USD for a 1-3 month horizon; the cleaner trade is curve repricing rather than outright FX, with upside if the BoE signals patience and the market starts pricing no hikes.
• Pair trade: short UK domestic banks (LLOY, NWG) versus long UK insurers/asset managers over 3-6 months; banks lose most if forward rate expectations are walked down, while insurers are less exposed to immediate margin compression.
• Buy downside protection on UK small-cap/cyclicals via FTSE 250 puts into the September MPC; these names are most vulnerable if the BoE delays, growth slips, and the market de-risks the policy path at the same time.