For this reason he feels “a very big interest rate rise” is needed to reassure markets.
Tombs says that rates will likely rise by 0.5 per cent in the next month or so, but thinks that rates will generally peak in the UK at around 2.75 per cent, rather than the markets' current expectation of 4 per cent.
The peak level of interest rates in a particular cycle is known as the terminal rate of interest.
In that scenario, index-linked government bonds would sell-off as those assets are presently pricing in rates at over 4 per cent.
Sterling service
One of the key determinants of the inflation rate in the coming months is likely to be the performance of sterling against its peer currencies.
Indeed, BoE policymaker Catherine Mann cautioned earlier this year that, almost regardless of the outlook for the economy or energy prices, rates would have to rise roughly in line with those of the US, because US rate rises boost the value of the dollar.
If the dollar is strengthening against sterling then UK households must pay more for those commodities priced in dollars, while weak sterling makes imported goods generally more expensive, generating inflation.
The new energy policies announced by the government, as previously mentioned, add more than £100bn to government borrowing, which would be expected to put downward pressure on the pound.
David Madden, market analyst at Equiti, says sterling fell sharply when it became apparent that an energy stimulus would be announced by the new prime minister, but this means “the impact of it may now be in the price”.
Zangana says the impact will be felt in terms of gilt yields, which could rise sharply – something that would lead to weakness in sterling. He says the BoE needs to send a signal to markets that it can control inflation or else sterling will remain unpopular.
Dall’Angelo takes the view that EU countries will be unable to stimulate economic growth to the same extent as is happening in the UK, meaning a Eurozone recession is likely, placing pressure on demand within the UK economy but perhaps easing the market jitters around the currency.
David Thorpe is special projects editor at FTAdviser
