Bank of England set to raise rates to 5.25% as high inflation persists

* BoE expected to raise rates to 5.25% from 5% on Aug. 3

* Repeat of June's half-point rate rise seen as possible

* UK inflation of 7.9% remains the highest in the G7

* Markets and economists see rates hitting 5.75% this year

LONDON, July 28 (Reuters) - The Bank of England looks likely to raise rates by a quarter-point to 5.25% on Aug. 3, though economists and markets see a risk of a repeat of June's surprise half-point hike as inflation remains hotter than in other big economies.

Both the U.S. Federal Reserve and the European Central Bank increased interest rates by a quarter of a percentage point this week, but unlike the BoE, markets think they are at or near the end of their rate-tightening cycle.

In contrast, bets on where BoE rates will peak have swung sharply since the central bank's last rate move on June 22 as investors try to work out if Britain has a deep-rooted inflation problem, or if rapid price growth is on the cusp of the sharp slowdown seen elsewhere.

"Where rates go after August will depend on the extent to which second-round effects persist," said Andrew Goodwin, chief UK economist at Oxford Economics, referring to the knock-on impact on wages and prices of last year's surge in energy costs.

Expectations for peak BoE rates reached 6.5% on July 11 after data showed record wage growth. But they fell back after a bigger-than-expected decline in consumer price inflation. Investors are now split fairly evenly between a peak of 5.75% or 6% late this year or early in 2024.

The surge in rate expectations has pushed mortgage costs to their highest since 2008, and higher rates are weighing on house-building and some other sectors. A survey on Monday showed private-sector growth had fallen to a six-month low this month.

FINELY BALANCED?

Most economists polled by Reuters this week see rates going up to 5.25% from 5% next week and peaking at 5.75%, but for many the decision is finely balanced.

"We believe the MPC will still want to send a strong signal on inflation," said economists at HSBC, who expect a rate rise to 5.5%, in what would be the central bank's 14th straight hike.

BoE Governor Andrew Bailey said this month that it was "crucial we see the job through" to curb inflation, and Deputy Governor Dave Ramsden said that even after recent falls, inflation remained "much too high".

Consumer price inflation dropped to 7.9% in June from 8.7% in July, a far bigger decline than markets had expected and one that brought it in line with what the BoE forecast in early May, when markets expected rates to peak at around 5%.

Still, that inflation rate is nearly four times the BoE's 2% target and double the rate in the United States. Ramsden said the fall had been driven more by short-term moves in energy prices, with less softening in longer-term pressures.

The picture from Britain's job market is mixed. Wage growth excluding bonuses held at an annual rate of 7.3% in the three months to May, the joint highest since records began in 2001. However, unemployment rose unexpectedly to a 16-month high of 4% as more people entered the labour market, and employers advertised fewer job vacancies.

"The interpretation of the data ... is dependent on the eye of the beholder and could be deployed to make the case for (increases of) either 25 basis points or 50 basis points," RBC economists Peter Schaffrik and Cathal Kennedy said.

Following the end of Silvana Tenreyro's tenure on the BoE's Monetary Policy Committee, fellow external member Swati Dhingra is likely to be alone in making the case that producer price inflation - rather than wage growth - is a better guide to future consumer price inflation trends.

Annual producer price inflation fell to 0.1% in June, its lowest since December 2020, down from a high of nearly 20% last July, which it hit just a few months before CPI peaked at 11.1%.

Former Kroll Institute chief economist Megan Greene will replace Tenreyro. She is likely to be more hawkish than Tenreyro, and wrote this month that it would be "a mistake" for central bankers to assume inflation would automatically return to pre-pandemic levels.

FRESH FORECASTS

The BoE will also update its growth and inflation forecasts alongside the rate decision, both of which are likely to be lower than in May due to higher market rate expectations - an important component of the forecast.

On Tuesday the International Monetary Fund forecast Britain's economy would grow 0.4% this year - the second slowest in the Group of Seven advanced economies, after Germany.

In normal times, the extent to which the BoE's forecast for inflation in two or three years' time deviates from its 2% target also served as a signal of how much the central bank agreed with market rate bets.

However, in recent months the BoE has placed less emphasis on its medium-term forecast. Bailey and BoE Chief Economist Huw Pill have instead focused on the risk of inflation persistence that is not captured in the central forecast.

"If the BoE believed its own forecasts, it would be cutting rates, not raising them," HSBC said.

(Reporting by David Milliken; Editing by Kirsten Donovan)