The Bank of England raised interest rates by 0.5 percentage points on Thursday, holding out the prospect of a further big increase in November, as central banks across the world seek to bring inflation under control.
The rise, to 2.25 per cent, the UK’s highest level since 2008, came as central banks around the world tightened policy in the wake of a third successive 0.75 percentage point rate increase 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 move was smaller than markets had expected and sterling later cut its gains on the day against the US dollar, at around $1.13; it is still trading near its weakest level since 1985 against the US currency.
Central banks around the world are rapidly increasing interest rates as they seek to fight the worst bout of inflation for decades, with the Fed leading the charge. But the majority of the BoE’s Monetary Policy Committee resisted pressure to match the pace set by the Fed, reflecting worries about the state of the British economy.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said that decision provided “reassurance that it is focused on the outlook for consumer price inflation and evidence of emerging slack in the economy, rather than with arbitrarily keeping up with the Joneses”.
The BoE said it now expected UK gross domestic product to fall 0.1 per cent in the third quarter of the year, compared with August’s forecast of 0.4 per cent growth. This would mark a second consecutive quarter of decline, cementing fears that the economy is falling into recession.
It also suggested it would wait until November, when it updates its forecasts, to take a firmer view of the new UK government’s fiscal policy, which will be unveiled in a mini-budget on Friday.
Even as the central bank seeks to rein in inflation, Kwasi Kwarteng, the new chancellor, is set to try and jump-start the economy with debt-financed tax cuts and an emergency plan to hold down energy bills.
The MPC said that “should the outlook suggest more persistent inflationary pressures, including from stronger demand, the committee would respond forcefully, as necessary”.
Economists said this left the BoE’s path open to offset the tax cuts’ impact with a large rate increase at the November meeting. “In short, the Bank has indicated it will raise rates further to offset some of the boost to demand from the government’s fiscal plans,” said Paul Dales, chief UK economist at Capital Economics.
The MPC said the government’s energy price guarantee would lower inflation in the short term, with CPI now likely to peak at just under 11 per cent in October, earlier than expected — in contrast with previous private-sector forecasts of levels of around 15 per cent next year.
But it said inflation would hover around 10 per cent for several months, not necessarily low enough to dampen expectations of big price rises.
“Many of our members think that the peak [in inflation] will come next year and so may price accordingly, running the risk that inflationary expectations become 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 — favoured a bigger, 0.75 percentage point increase, arguing that acting faster now could help the BoE avoid “a more extended and costly tightening cycle later”.
Swati Dhingra, a newcomer to the committee, favoured a more modest 0.25 percentage point move on the grounds that economic activity was already weakening.
The BoE also confirmed it would press ahead with plans outlined in August to reduce the stock of assets it had amassed under previous quantitative easing programmes. It is aiming for gilt sales of £80bn over the next 12 months, which would bring total assets on its balance sheet down to £758bn.