5 June 2026: A rate hold is likely, but a July hike cannot be ruled out

Bank of England Governor Andrew Bailey warned this week that the UK risks a “vicious circle” of rising borrowing costs on its £3 trillion national debt. Higher interest rates charged by international investors buying government bonds will strain the fiscal rule and force spending cuts, which in turn push borrowing costs higher.

This cycle threatens to derail Chancellor Rachel Reeves’s plans for public finances.

Bailey explained the mechanism at a House of Lords committee. Rising debt-servicing costs strain the fiscal rule, forcing the government to cut spending. These cuts undermine investor confidence, pushing borrowing costs even higher. The cycle reinforces itself, making debt management harder with each turn.

The UK has seen interest rates on its government bonds rise faster than in any other G7 nation. Before the US-Iran conflict, the government was already projected to spend over £100 billion annually on debt interest. That figure is now expected to rise as global energy costs remain elevated.

Bailey also flagged concern about public-sector wage growth outpacing private-sector pay. Public-sector pay rose 4.8% annually in the first quarter of 2026, compared with 3.0% in the private sector. This marks the longest period since 2011 in which public-sector pay growth has exceeded private-sector growth.

Higher public-sector pay increases government spending, further straining the fiscal rule. Bailey said the widening gap between public and private pay will feed into higher inflation if it continues.

UK government bond yields have hit their highest levels since 2008. Bailey stressed that balanced public finances are essential to restore market confidence. The fiscal rules matter, he said, because markets are watching the UK’s ability to manage debt.

With real wages, which are total wages adjusted for inflation, barely growing and unemployment rising to 5.0% in March, the economy faces headwinds. The Bank of England held rates steady at 3.75% in April and is watching global energy developments before deciding on future moves.

The likelihood of a Bank of England interest rate rise has increased after Megan Greene backed calls for higher borrowing costs.

Greene, a member of the Bank of England’s Monetary Policy Committee, says the “case for hiking rates grows as the conflict wears on” and believes “a tightening in monetary policy over the next few weeks or months may be necessary”.

Greene told The Times she considered voting for a rate rise at the MPC’s last meeting, when rates were left unchanged by an eight-to-one vote. Huw Pill, the Bank’s Chief Economist, was the only committee member to back an increase.

She said: “The risk of acting, even if inflation proves to be less persistent, is less severe than the risk of failing to act.”

Her comments come ahead of the Bank’s next interest rate decision on 18th June.

Sir Keir Starmer has hit out at Elon Musk, accusing him of trying to ‘whip up division’ in the UK with his response to Henry Nowak’s murder.

During a visit to York on Thursday, the prime minister told Sky News that Musk was using Henry Nowak’s death to “interfere in our politics.”

He said: “We need to assert who we are as a country because Musk again has been interfering in our politics in the last few days, trying to whip up division. That is not who we are in Britain.”

Adding fuel to the fire, Reform UK leader Nigel Farage has been criticised for failing to condemn the unrest in Southampton earlier this week. One observer commented that, with the country having a “tradition of summer riots”, Farage has provided the context in which this year’s riots are likely to happen.

The pound briefly rallied yesterday as a rate hike on June 18th became more likely, but it faded as risk appetite weakened amid developments in the Middle East. It fell back to close virtually unchanged at 1.3424.

The publication of employment data culminates later today with the release of non-farm payroll figures for May.

There has been a growing view among traders and investors that the May release will show another rise in job creation, with more than 100k new jobs created, and that the FOMC will likely leave rates unchanged at its June meeting despite rising inflation.

The number of Americans filing first-time unemployment claims rose by 13,000 last week to 225,000, according to US Labour Department data.

The figure exceeded market expectations of 214,000 for last week, following the previous week's downwardly revised figure of 212,000.

The four-week moving average was 214,750, up 6,500 from the previous week's downwardly revised 208,250.

The US economy added 115,000 jobs in April, well above expectations of a 65,000 gain.

The unemployment rate was 4.3% in April, unchanged from March.

The latest figures for job cuts showed US employers made 97k cuts in May, according to Challenger, Gray & Christmas, up from 83,387 in April, the highest monthly total since January.

It also marked the third consecutive monthly increase and the largest May figure since 2020, with artificial intelligence cited as the leading cause of layoffs for a third straight month.

The tech sector accounted for 38,242 cuts, its biggest monthly tally since August 2024, while transportation cut 6,909 jobs, services made 6,288 layoffs, and fintech shed 5,731 jobs.

However, despite the recent acceleration, year-to-date cuts stand at 397,755, down 43% on the same period last year, when reductions in the Federal workforce pushed totals to historic highs. Excluding that distortion, 2026's year-to-date figure was broadly in line with 2024.

The International Monetary Fund has urged the Federal Reserve, in its first policy meeting led by new Fed Chair Kevin Warsh, to remain cautious on rates due to persistent upside inflation risks from energy price shocks and ⁠the increasing pass-through of higher tariff costs.

IMF spokesperson Julie Kozack told a ​regular press briefing that the Fund now forecasts that a return of inflation to ​the Fed's 2% target will ​be delayed to the end of 2027, compared ‌with ⁠its previous forecast of mid-2027 for reaching that goal.

"We've now delayed the return ​to the target," ​Kozack said. "We do see sort of upside risk to inflation, ​and that implies that ​the ⁠Fed's policy actions will need to proceed with caution and will ⁠need ​to be carefully calibrated ​to incoming data."

The Fed's policy-setting committee next meets ​on June 16-17.

San Francisco Fed President Mary Daly does not get a vote at the FOMC meeting this year, but sits at the centre of the AI “revolution. Asked whether she thinks the rapid growth in artificial intelligence has created a bubble, Daly said, "It’s only a bubble if AI doesn’t deliver."

"We have a lot of promise in AI and a lot of growth," she said, describing the AI-related construction she's seeing across her region in the West. "We have to wait a couple of years to see if it really delivers."

"It certainly feels like this is transformative," she said in an interview on Fox Business. It will also take time to determine whether the inflation caused by the war in Iran will require any changes to the federal funds rate, she added. Daly is looking for two pieces of information.

One is how long the war lasts. The second is whether higher oil prices bleed into broader inflation, such as services.

Currently, monetary policy is in a good place, she said.

The dollar index initially gave up most of its gains from Wednesday, but recovered to close the day almost where it started. It fell to a low of 99.18 but recovered, closing at 99.45.

Expect the ECB to hike policy rates by 25bp on June 11, bringing the deposit rate to 2.25%, in line with market pricing and consensus. Recent statements from ECB Governing Council members on both the hawkish and dovish sides of the spectrum have led markets to believe a hike will receive a majority of votes.

The size and, particularly, the persistence of the energy shock mean that “We can no longer look through this shock. The risk of de-anchoring inflation expectations is rising”, according to German economist and ECB Board Member Isabel Schnabel. The main reason for the ECB's hike is to keep inflation expectations anchored by signalling a willingness to act.

Since the April meeting, headline inflation has evolved broadly as expected by the ECB, while core inflation has surprised on the upside, driven by a strong services reading in May.

Oil futures have moved higher relative to the ECB staff's March baseline projections, so expectations are that the new projections will raise the 2026 inflation forecast to 2.9% YoY and 2027 to 2.2% YoY.

Growth data has surprised on the downside, both in Q1 GDP and in Q2 survey-based indicators, so the market expects downward revisions to 2026 GDP growth to 0.6% YoY and to 2027 GDP growth to 1.2% YoY.

As the new staff projections likely assume around 68 bp of hikes in the technical assumptions, market analysts believe they provide support for two rate hikes this year.

Germany is set to be the main economic beneficiary among Europe’s large economies as the Eurozone raises defence spending, Fitch Ratings says in a new report.

Fitch projects that Germany’s defence spending will rise by about 1% of GDP between 2025 and 2028 – about twice the median increase under the narrower current measure. In June 2025, European NATO countries agreed to increase spending from 2% of GDP to 3.5% by 2035 under NATO’s definition, and to 5% including allied defence spending.

The macroeconomic impact on Germany is likely to be significant. As with any fiscal easing, higher defence spending should lift output.

Fitch said that, over these three years, additional defence spending is more than 60% higher than the combined increase in France, Italy and Spain, and equivalent to as much as 0.3% of eurozone GDP.

Germany also plans to finance this largely through increased borrowing, rather than by reallocating existing spending, thereby adding to the growth impact.

Aside from financing, the broader economic benefits of higher defence spending depend partly on the economy's capacity in relevant sectors, especially as European countries are now seeking to reduce their dependence on imported equipment.

France’s large aerospace industry also stands out, but Germany has greater overall capacity in sectors related to defence spending.

Sectors where defence spending typically has a material footprint account for about 12% of GDP in Germany, compared with about 7% in France and the UK.

Considered together, Fitch forecasts that the economic boost will be much greater in Germany than in the other large European economies, adding 0.8pp to German GDP cumulatively in 2026-2028.

The Irish economy recorded a sharp contraction in the first three months of the year, led by a decline of more than one-third in factory output, according to the country’s statistics agency.

Irish economic data is highly volatile because it is influenced by the activities of a small number of very large U.S. companies.

The scale of the output decline suggests that figures to be released later today will show a first-quarter decline across the Eurozone as a whole.

The Central Statistics Office said it now estimates that gross domestic product was 12.1% lower in the three months to March than in the previous quarter.

The CSO had previously estimated that GDP fell by 2%.%.

The Euro again followed the dollar yesterday, initially gaining but then falling back as traders’ lack of confidence in current market conditions weighed. It reached a high of 1.1645 but closed at 1.1610.

Have a great day!