The Bank of England on Thursday raised its key interest rate from 1.75 percent to 2.25 percent and said it would continue to “respond vigorously if necessary” to inflation despite slowing economic growth.
The BoE estimates that the British economy shrank by 0.1% in the third quarter – partly due to a bank holiday for Queen Elizabeth’s funeral – which, combined with a fall in output in the second quarter, meets the definition of a technical recession.
Economists polled by Reuters last week had expected a repeat of August’s interest rate halving, but financial markets were betting on a three-quarter point rise, the biggest since 1989, apart from a brief failed attempt to prop up sterling in 1992.
The BoE’s move follows the decision by the US Federal Reserve on Wednesday to raise the key interest rate by three-quarters of a percentage point, as central banks around the world grapple with the impact of post-COVID job shortages and the impact of Russia’s invasion of Ukraine on energy prices.
“If the outlook points to more sustained inflationary pressures, including a stronger impact on demand, the Committee will respond strongly if necessary,” the BoE said, using similar words to its policy intentions in previous months.
The BoE’s Monetary Policy Committee voted 5-4 to raise interest rates to 2.25%, with Deputy Governor Dave Ramsden and non-MPC members Jonathan Haskel and Catherine Mann voting for an increase to 2.5%, while new MPC member Swati Dhingra wanted lower interest 2% of the increase.
The MPC also voted unanimously to reduce the BoE’s £838bn holding of government bonds by £80bn next year, allowing the bonds to mature and be actively sold from next month. This is in line with the target set in August.
The BoE expects inflation to peak at just under 11% in October, down from a peak of 13.3% forecast last month before Liz Truss won the leadership of the Conservative Party and became British prime minister on a promise to cap energy tariffs and cut taxes.
Inflation will remain above 10 percent for several months after October before easing, the BoE said. Consumer price inflation fell from a 40-year high of 10.1 % in July to 9.9 in August, the first drop in nearly a year.
New finance minister Kwasi Kwarteng will give more details on Friday about the government’s financial plans, which could include more than £150 billion in stimulus measures.
The BoE said it would assess its impact on monetary policy at its November meeting. At the same time, it was noted that even if the energy price ceiling would slow down inflation in the short term, it would increase the pressure in the long term.
Before the rate decision, financial markets expected the BoE to raise rates to 3.75% by the end of the year, with a peak of 5% reached in mid-2023. Less than a year ago, BoE interest rates were at a record low of 0.1 %.
Starling fell to its lowest level against the United States dollar since 1985 after the Fed’s decision on Wednesday, although it held against the euro. (This story changes the proposed gold reduction in paragraph 7 from £100 billion to £80 billion).