The Bank of England raised interest rates by 0.5 percentage points to 2.25 per cent on Thursday, setting out the prospect of a further big increase in November to bring inflation under control.
The move takes the BoE’s benchmark rate to its highest level since the start of the global financial crisis in 2008. However, the nine-member Monetary Policy Committee held back from the even more aggressive approach adopted by peers at the European Central Bank and US Federal Reserve.
The Fed implemented a third successive 0.75 percentage point increase this week.
Sterling cut its gains on the day against the US dollar after the BoE’s rate increase, which was less than markets expected. At around $1.13, sterling is still trading near its weakest level since 1985 against the US currency.
The MPC 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.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said the BoE’s decision not to follow other central banks with a 0.75 percentage point rise 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.
The MPC suggested it would wait until November, when it updates its forecasts, to take a firmer view on the effects of the new government’s fiscal policy. Chancellor Kwasi Kwarteng’s “growth plan”, set to be announced on Friday, was likely “to provide further fiscal support” and “to contain news that is material for the economic outlook”, it said.
It added that, “should the outlook suggest more persistent inflationary pressures, including from stronger demand, the committee would respond forcefully, as necessary”.
Economists noted this signalled an intention at the BoE to offset the effects of tax cuts with a large rate increase at the November meeting.
Paul Dales, chief UK economist at Capital Economics, said the bank’s statement contained a “not-so-subtle reference” to Friday’s mini-Budget. “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,” he said.
The energy price guarantee the government had already announced would lower inflation in the short term, the MPC said, with CPI now likely to peak at just under 11 per cent in October, earlier than expected. But inflation would still hover at around 10 per cent for several months, and this would not necessarily be enough to stop high inflation expectations driving household and business behaviour.
Highlighting this warning about further price pressures in the pipeline, Kitty Ussher, chief economist at the Institute of Directors, said that “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”.
The BoE also confirmed that it would press ahead with plans outlined in August to reduce the stock of assets it had amassed under previous quantitative easing programmes, aiming for gilt sales of £80bn over the next 12 months, bringing the total down to £758bn.