The Bank of England raised interest rates by 0.5 percentage points on Thursday, maintaining the prospect of another big hike in November as central banks around the world seek to bring inflation under control.
The rise to 2.25 percent, Britain’s highest level since 2008, came as central banks around the world tightened policy in the wake of a third consecutive 0.75 percentage point rate hike by the US Federal Reserve.
Switzerland and South Africa raised interest rates by 0.75 percentage points, while Norway increased by 0.5 percentage points and Japan intervened to strengthen the yen for the first time in 24 years.
The BoE’s measures were less than the markets had expected and sterling later pared the day’s gains against the US dollar to around $1.13; it is still trading near its weakest level since 1985 against the US currency.
Central banks around the world are rapidly raising interest rates as they seek fight the worst bout of inflation for decades with the Fed at the helm. But the majority of the BoE’s monetary policy committee resisted pressure to match the pace set by the Fed, reflecting concerns about the state of the UK economy.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said the decision provided “reassurance that it is focused on the outlook for consumer price inflation and evidence of emerging slack in the economy, rather than keeping up with the Joneses arbitrarily”.
That BoE said it now expected UK gross domestic product to fall 0.1 percent in the third quarter of the year, compared with August’s forecast of 0.4 percent growth. This would mark a second straight quarter of decline and cement fears that the economy is slipping into recession.
It also suggested it would wait until November, when it updates its forecasts, to take a firmer view on the new UK government’s fiscal policy, which will be revealed in a mini-budget on Friday.
Even as the central bank tries to curb inflation, new chancellor Kwasi Kwarteng is poised to try to jump-start the economy with debt-financed tax cuts and an emergency plan to keep energy bills down.
The MPC said that “if the outlook suggests more sustained inflationary pressures, including from stronger demand, the Committee will respond strongly as appropriate”.
Economists said this left the BoE’s path open to offset the impact of the tax cuts with a big rate hike at the November meeting. “In short, the Bank has indicated that it will raise interest rates further to offset some of the demand boost from the government’s fiscal plans,” said Paul Dales, UK chief economist at Capital Economics.
MPC said the government’s energy price guarantee will lower inflation in the short term, with the CPI now likely to peak at just under 11 per cent. in October, earlier than expected – in contrast to previous forecasts from the private sector of levels of around 15 per cent. next year.
But it said inflation would hover around 10 percent for several months, not necessarily low enough to dampen expectations of big price increases.
“Many of our members think that the top [in inflation] will come next year and can therefore price accordingly and risk inflation expectations becoming self-fulfilling,” said Kitty Ussher, chief economist at the Institute of Directors.
In its deliberations on Thursday, the committee split three ways, with the majority – including BoE governor Andrew Bailey and chief economist Huw Pill – voting for the 0.5 percentage point move.
Three members – Jonathan Haskel, Catherine Mann and Deputy Governor Dave Ramsden – favored a larger increase of 0.75 percentage points, arguing that faster action now could help the BoE avoid “a more extended and costly tightening cycle later”.
Swati Dhingra, who is new to the committee, favored a more modest 0.25 percentage point on the grounds that economic activity had already weakened.
The BoE also confirmed it would continue with plans outlined in August to reduce the amount of assets it had accumulated under previous quantitative easing programmes. It is targeting gold sales of £80bn. over the next 12 months, which will bring total assets on the balance sheet down to £758bn.