Financial markets are betting the Bank of England will more than double interest rates by May next year, as concern mounts about further rises in UK inflation.

The shift in expectations in the swap market — which anticipates interest rates of 4 per cent in May compared with 1.75 per cent today — are among the biggest swings in recent years.

The shift in expectations, fuelled by persistent increases in forecast inflation and soaring energy prices, has been reflected in other markets. In the UK gilt market the cost of two-year borrowing for the government has risen more than 1 percentage point this month in the biggest rise on Bloomberg records going back to 1992.

The market moves will be reflected in the cost of corporate borrowing and fixed-rate mortgage deals, affecting companies and households even before the BoE takes decisions on interest rates in the months ahead.

Higher borrowing costs will be a further drag on UK economic activity and household and corporate finances already suffering from high energy, fuel and food prices — although City economists expect less of a jump in rates.

Traders in the overnight index swap market, which sets prices based on expectations of future official interest rates, are now betting that interest rates will rise to 2.75 per cent by the BoE’s November meeting before hitting 4 per cent in May.

Separately, the yield on two-year government bonds — indicating the average interest rate over the next 24 months — is now trading at 2.94 per cent, compared with 1.83 per cent just a month ago.

“It’s been one-way traffic since the beginning of August,” said Matthew Russell, fixed income fund manager at M&G Investments, about the gilt moves. “The moves have been outsize.”

Traders have become concerned as UK inflation has exceeded expectations almost every month this year, rising to 10.1 per cent in July.

Russell said Citigroup’s forecast that UK inflation would hit 18.6 per cent next year “drew quite a lot of attention to the [short duration] gilt market and that combined with the situation in the energy markets in Europe, plus thin summer liquidity in the markets, has accounted for the sharp rise in gilt [yields]”.

With energy prices continuing to put pressure on inflation, the new retail gas and electricity price cap for October to December will be announced on Friday. Analysts expect Ofgem, the sector regulator, to raise the annual cost of energy for an average household from £1,971 to more than £3,500.

Traders in government bond and interest rate futures markets pushed the expectations of interest rates higher on each piece of bad news on inflation.

Craig Inches, head of rates and cash at Royal London Asset Management, said the forecast that the BoE would raise rates to 4 per cent was reasonable. “I just don’t see a situation in the short term where the inflation pressures are going to get any easier,” he said.

The financial market forecasts for interest rates reflect the central bank’s comments that it would be willing to act “forcefully” if it felt inflation had become embedded into company and household expectations.

Economists are much less willing to bet on the BoE being so aggressive with monetary tightening. The consensus among City economists is that interest rates will peak at 2.5 per cent, but expectations are changing.

Paul Dales, chief UK economist at Capital Economics, which expects interest rates to reach 3 per cent, said market expectations had “jumped” in the past few weeks.

“At this stage I wouldn’t really want to rule anything out,” said Dales. He added that while 4 per cent interest rates were not “completely implausible anymore . . . history shows that the markets tend to overdo the extent of tightening cycles. So at the moment, my hunch is that the markets have gone a bit too far”.

Are we heading towards a global recession? Our economics editor Chris Giles and US economics editor Colby Smith discussed this and how different countries are likely to react in our latest IG Live. Watch it here.