Traders are diverging from European central banks on the outlook for interest-rate hikes, driven by a surge in energy prices. Money markets now imply four additional quarter-point rate rises from the European Central Bank and five from the Bank of England over the next 12 months. This stands in contrast to policymakers, with the ECB reiterating it will not pre-commit to further steps after recent hikes, while economists forecast just one or two more. In the UK, where the BOE has not raised rates this year, Deputy Governor Dave Ramsden said he was comfortable with current policy, though acknowledging upside risks. The bank meets on Thursday with no change expected.

Earlier this year, Governor Andrew Bailey pushed back on market pricing for two hikes, less than half of what is currently priced in. "The pricing is completely at odds with what the Bank of England is telling us," said James Smith, an economist at ING Groep NV. The extent of the divergence is unusual due to the unpredictability of the conflict in the Middle East and its knock-on effects on inflation. A fresh surge in energy prices has revived concerns, with natural gas jumping to levels last seen in 2022 and oil futures climbing above $108 a barrel as a critical Saudi Arabian pipeline remains offline.

As inflationary fears seep into markets, shorter-dated government bond yields have spiked. German and UK two-year yields are on their longest weekly streak of advances in several years. The BOE is expected to address the increase in energy costs at its upcoming rate meeting, with swaps implying a 30% chance of a hike. ECB President Christine Lagarde said euro-area inflation will stay elevated for some time, acknowledging the split with rates pricing by stating, "Markets do what they have to do, and we do what we have to do."