The Bank of England raised borrowing costs and delivered a remarkably hawkish message this morning, keeping rate differentials well-supported and extending the pound’s advance against the euro and the dollar. Surprising market participants who had expected a number of dovish dissents, eight of nine members of the Monetary Policy Committee opted to raise the Bank Rate by a quarter-percentage-point to 4.00%, with external member Catherine Mann voting in favour of a half-percentage-point move.

Policymakers avoided committing to further tightening but clearly set the stage for additional moves. In the statement accompanying the decision, officials warned that although evidence remained elusive, the likelihood of material second-round spillovers from energy prices to wages and prices had risen since September and “could remain a risk for some time”. Updated projections in the Monetary Policy Report showed headline consumer inflation peaking at 4.9% in the second quarter of 2027, with prices rising as much as 6.2% under an adverse scenario, and in written comments, Governor Andrew Bailey said: “Today’s increase shouldn’t be seen as the first in an inevitable long sequence of hikes. But, unless the conflict in the Middle East is resolved, neither does it seem to be the last increase”.

Markets are responding aggressively. Gilt yields are climbing across the policy-sensitive front end of the curve and sterling is adding to this week’s gains as tightening expectations firm. As we went to print, swap markets were expecting two additional rate increases over the next year – with coin-toss odds on the next move coming as soon as December – and the pound was close to erasing its losses on a year-to-date basis.

This reaction may prove overdone, given that the decision comes after Tuesday’s Democratic sweep in the US midterms gave central bankers and bond markets some breathing room. The prospect of gridlock in Washington reduced the likelihood of major changes to fiscal and monetary policy, easing upward pressure on long-term yields, and oil prices plunged to a two-month low after Vice-President JD Vance blamed the war with Iran for the Republican defeat in a post on X, leading investors to suspect the White House is now intent on ending the conflict. Many investors now expect a short, performative bombing campaign followed by a declaration of victory, with the American blockade lifted soon thereafter and traffic through the Strait of Hormuz returning to some semblance of normal within months.

Whether or not this optimism is justified, we think tightening expectations have room to fall further and faster outside the US over the next two months, meaning the dollar could hold its altitude into year-end even if the Fed is seen delivering fewer hikes. The Bank of England, European Central Bank, Bank of Japan, Bank of Canada and other advanced-economy central banks are facing difficult trade-offs between high inflation and weak domestic demand, whereas in the US – for now, at least – high prices have been accompanied by resilient consumer spending and investment. A bullish long-term view remains justified, but the pound, like its counterparts elsewhere, is likely to find its gains capped in the short term.