Some predict that the UK economy would deteriorate so rapidly that the BOE will not need to hike interest rates to 7% to reduce inflation

Andrew Bailey, Governor of the Bank of England, was teaching inflation to youngsters on the same day as UK interest-rate expectations reached their highest level since 1998.

Bailey was speaking during an interview on CBBC's Newsround, a TV show geared at children as young as seven, about how rising mortgage prices had forced families to make "very difficult choices." On the top page of newspapers in London, interest rate warnings and bright red lines pointing skyward are prominently shown.

While the cost-of-living issue in the United Kingdom has been festering for months, this was the first week in which concern over interest rates seemed to rise on its own. There was no political drama to shake markets or a major economic surprise — just the sense that the country is coping with out-of-control inflation and that interest rates must continue to increase.

And everyone's wondering how much higher interest rates and bond yields can go. On the trade floors of London, there are a variety of responses. Some predict that the UK economy would deteriorate so rapidly that the BOE will not need to hike interest rates to 7% to reduce inflation. Others attribute the continued rise in borrowing costs on the robustness of consumer spending.

While bond rates have risen globally, the UK has seen some of the most dramatic increases due to sustained inflation. The Bank of England has already raised interest rates 13 times since late 2021, yet inflation, at 8.7%, has surpassed expectations for four months in a row and remains well above the 2% target.

It was a difficult week for investors. The benchmark 10-year rate peaked at 4.7%. Other examples of such high yields occurred in October, when the country was in the clutches of Prime Minister Liz Truss's budget disarray, and during the 2008 global financial crisis. The blue-chip FTSE 100 Index fell 3.7% in a week, the worst weekly drop since March.

Traders priced in a one-in-three possibility of the key rate climbing to 6.75%, a level last seen when the Spice Girls and Oasis ruled the British music charts. This compared to bets on a 5% peak just a few months ago.

Ales Koutny, the head of international rates at Vanguard, stated that rates "absolutely" might increase to 7% if data continues to surprise to the positive. "We have noticed a significant change in BOE rhetoric. Prior to that, it was looking for a method to stop raising rates. It seems like the BOE had made up its mind to take whatever necessary action once we reached 4% and continued to receive improved economic statistics.

The property market reflects the pressure. According to a research from mortgage company Halifax, UK home prices are dropping at their quickest yearly rate since 2011. Furthermore, there is concern that when rate increases spread throughout the banking system, other weaker sectors of the economy would experience pressure.

Increasing interest rates increase the likelihood of something going wrong and going wrong spectacularly, according to Mike Riddell, macro portfolio manager at Allianz Global Investors. Investors are divided over whether UK bonds are a good time to lock in hefty returns or are about to experience another selloff due to rising rate forecasts.

Riddell, a member of the bull side, said that central banks have already tightened rates too much and that gilts are a deal too good to miss. Short-dated gilts are popular with Samuel Zief, head of global FX strategy and markets at JPMorgan Private Bank, since they have strong yields and act as a cushion against additional shocks.

Liquidity has dried up, which is one of the factors contributing to the UK bond market's volatility, according to Koutny of Vanguard. He claims that many investors withdrew from the market following the mini-budget crisis of the previous year and are now looking to the data for stronger indications that a slowdown may be approaching.

According to some market observers, the issue is that investors have repeatedly lost money by attempting to predict UK interest rates. Given the current climate of unpredictability and volatility, according to Mizuho rates strategist Evelyne Gomez-Liechti, investors will be less inclined to purchase gilts.