Britain's rate rise is settled, but the budget has no energy headroom

The noise is 3.5%, the signal is monthly services

The number markets fixed on on 21 October was 3.5% headline inflation. ONS data show CPI rising from 3.1% to 3.5% in September, above the 3.4% consensus, while services inflation jumped from 3.4% to 3.7%. The headline cemented expectations that the BoE will lift Bank Rate from 3.75% to 4% on 5 November. Joe Calnan of iBanFirst notes the rise was almost fully priced before the release. The print confirms existing pricing rather than adding new information.

The quiet parameter lies in September's monthly services data. The Central Banks' Watcher's breakdown of ONS figures shows services prices flat on the month in September. Core services — rents and domestic services excluding energy — fell 0.1% on the month. Most of the annual jump comes from base effects in airfares and VAT; airfares were 8% cheaper on the year in August but 3.9% dearer in September. On pay, core wage growth eased from 3.8% in July to 3.4% in August, and regular private sector pay growth held at 3.0%. The second-round effect of energy, meaning the price shock embedding itself in wages and service prices, does not show up in the August and September data.

Imported energy is carrying inflation

September's 0.4-point jump came from imported energy. Motor fuel rose 29.8% on the year and heating oil 104.9%; Investing.com estimates the two together added about 0.2 points to the headline. Diesel averaged 192.5p a litre in September, and the RAC says the average passed 200p in early October. Reuters reports that crude returned above $110 a barrel on 21 October after a brief pullback.

On household bills, the pressure carries into 2027. Ofgem's household energy price cap rose 4% in October to about £1,935. Capital Economics expects a 13% bill increase in January and sees inflation peaking at about 4.2% next year. The BoE's own forecast is about 3.75% for the fourth quarter and slightly above 4% in early 2027.

That leaves a narrow corridor for a 3.75% Bank Rate. As Calnan puts it, a 25-basis-point rise will not bring gas prices down; it only adds to the strain on companies and households. The committee held by 6 votes to 3 on 16 September, with 3 members voting for a rise. For the majority to flip in November, just 2 members need to change their vote.

The real constraint is at the Treasury

The decisive constraint lies with the fiscal side, which presents a budget on 28 October. ONS data show public sector borrowing at £24.5 billion in September, against expectations of £23.9 billion and an OBR March forecast of £22.5 billion. The April–September total of £97.8 billion overshot the OBR projection by £6 billion. Chancellor John Healey presents his first budget on 28 October, and Capital Economics says the September data strengthen the case for a cautious one.

The bond market is already pricing the £6 billion slippage. TradingEconomics noted on 21 October that the 10-year gilt yield — the yield on UK government bonds — stood near 5.4%, close to multi-year highs. A budget that wants to fund energy support means extra issuance. Extra issuance pushes the 5.4% yield higher, and mortgage rates with it. Two-year fixed mortgage rates are already about 95 basis points above pre-conflict levels. Whether the BoE can stop at one rise therefore depends on the Treasury not enlarging its issuance needs on 28 October.

The same vice in Europe

Britain's constraint surfaced on the continent too on 21 October. France's 10-year yield reached 5% for the first time since 2002, and its spread over Germany widened to 157.5 basis points on the Ideal Investisseur series. Moody's reviews France's Aa3 rating on 23 October. In Greece, day-ahead power for 20 October delivery hit €247.82/MWh, the highest since 2023, and Athens will ask for fiscal flexibility at the 9 November Eurogroup. The common denominator across the 3 countries is the same. The energy shock demands budget support, and the bond market charges a premium for it.

What to watch

Three dates over the next 15 days will test the thesis: the 28 October budget, the 29 October ECB decision and the 5 November BoE decision. If the budget funds energy support with borrowing, the 10-year gilt yield should break above 5.4%. That would tighten the mortgage channel and give the BoE more room to avoid a second rise. More than 2 members voting to hold in November would signal that the committee sees the energy shock as transitory. The quickest refutation would be a budget that funds energy support through tax rises, with the gilt yield falling below 5%.