Bank of England to hold rates but energy shock stirs talk of a hike

By Andy Bruce

MANCHESTER, England, Sept 17 (Reuters) - The Bank of England looks set to keep interest rates on hold on Thursday but investors are watching for any hint that surging energy prices could force it to follow the example of the U.S. Federal Reserve which raised borrowing costs a day earlier.

Most economists polled by Reuters last week expected the BoE to leave its Bank Rate on hold at 3.75% for the rest of the year, with only three of nine Monetary Policy Committee members seen voting for a hike this week.

Financial markets on Wednesday pointed to an 80% chance of a quarter-point rate hike in November, the first of around four expected by investors over the next year.

Economists are less convinced — around one in eight respondents in the Reuters poll expected a November hike.

But the recent jump in energy prices triggered by the Iran war is shifting opinion towards one — following hikes by the European Central Bank and the Fed.

The latter raised borrowing costs on Wednesday and signalled further increases ahead, citing stubborn inflation pressure driven in part by a jump in energy costs, fuelled by the war with Iran, that is also bearing down on Britain.

UK INFLATION ABOVE TARGET FOR MOST OF LAST 5 YEARS

British natural gas and Brent crude futures have leapt by almost 20% this month — bad news for a country heavily reliant on imported energy.

If sustained, that would push inflation — already at 3.1% in August — further above the BoE's 2% target, which the central bank has missed in all but three months of the last five years.

"We... expect the BoE to stay on hold this week as it seeks to avoid adding to market expectations for a rapid tightening cycle, but we continue to expect the Bank will go at the November (meeting)," J.P. Morgan economist Allan Monks said.

In a note to clients, he added there was "a clear argument for the BoE not delaying a hike any longer", given that energy price moves pointed to inflation peaking at 3.9% in February.

Others are not so sure, highlighting a cooling labour market and elevated market interest rates that are doing some of the BoE's work in tightening financial conditions.

"Nowhere is the gap between market pricing and policymaker expectations more stark than in the UK," said analysts from investment banking advisory firm Evercore ISI.

"(The) rates market is discounting roughly four-and-a-half hikes over the next year but the Bank leadership in our view still hopes to make it through without raising rates."

BoE Governor Andrew Bailey told reporters at the central bank's last rate-setting meeting: "Please do not leave this room thinking that the Bank of England is edging towards a hike."

U.S. asset management firm Franklin Templeton said on Wednesday that gilts looked "particularly attractive" as a cooling labour market and softer economic outlook augured for looser BoE policy than priced in by the market.

BOE COULD STOP SELLING LONG-DATED GILTS

Gilt investors are also waiting for the BoE's annual update on Thursday on its latest plans for reducing the size of its balance sheet by selling government bonds.

On Tuesday, the Telegraph newspaper reported that the central bank will cease sales of 20-year and 30-year gilts that have been hit hard by a global sell-off.

Doing so could offer some fiscal room for manoeuvre to finance minister John Healey as he prepares for his first budget statement on October 28.

The BoE could go further and stop selling any gilts to the secondary market, the Telegraph also reported, and sell them instead to the government's Debt Management Office, which would then add the equivalent sum to its own financing remit.

"(It) would result in the DMO being the sole supplier of gilts to the market and hence giving them total control of the gilt issuance strategy," wrote RBC Strategist Peter Schaffrik.

(Reporting by Andy Bruce; Editing by Catherine Evans)