The Bank of England made an unexpected decision to increase interest rates by half a percentage point in response to new information suggesting that British inflation would persist for a longer period.
The decision, reached by the Bank of England’s Monetary Policy Committee (MPC) with a 7-2 vote, resulted in the main interest rate rising from 4.5% to 5%, marking the highest level since 2008 and the largest rate increase since February.
This move came after the MPC observed higher inflation and wage growth since their previous meeting in May.
The MPC justified its decision by stating that recent data revealed significant positive developments that indicated a more prolonged inflationary period.
They also expressed concerns about the delayed resolution of domestic price and wage changes caused by external cost shocks. These effects are expected to take longer to unwind than they did to emerge, as stated by the MPC.
While economists surveyed had anticipated a rate increase to 4.75%, financial markets earlier in the day had assigned a nearly 50% probability to a rise to 5%, influenced by the release of higher-than-expected inflation data on Wednesday.
The possibility of a half-point rate increase had not been strongly hinted at by BoE policymakers leading up to Thursday’s announcement.
Among the MPC members, Silvana Tenreyro and Swati Dhingra opposed the rate hike, consistent with their opposition to previous increases this year.
They argued that the full impact of previous tightening measures had yet to be felt and that forward-looking indicators suggested a steep decline in inflation and wage growth in the future.
In a regular letter to the British finance minister, Jeremy Hunt, BoE Governor Andrew Bailey echoed the MPC’s statement, emphasizing the committee’s commitment to taking necessary actions to achieve sustainable inflation at the 2% target in the medium term.
Expectations for future rate hikes by the Bank of England have recently surged, leading to increased costs for new mortgages.
Prior to Thursday’s decision, financial markets anticipated the Bank Rate peaking at 6% by the end of the year.
In contrast, economists surveyed the previous week predicted a peak of 5%.
Despite the challenges posed by Brexit, the COVID-19 pandemic, and the gas price surge resulting from Russia’s invasion of Ukraine, Britain’s economy has managed to avoid the anticipated recession in 2023.
However, unlike most major developed economies, the country’s output has only marginally recovered to pre-pandemic levels.
According to BoE forecasts from the previous month, the projected growth for this year is a modest 0.25%.
The Bank of England’s decision to raise rates follows the European Central Bank’s quarter-point rate increase to 3.5% last week, as well as rate hikes by the Swedish and Norwegian central banks on the same day.
While Britain faces the challenge of stubbornly high inflation, with a slow decline from last year’s 41-year peak of 11.1%, other central banks also encounter similar difficulties.
The President of the Bundesbank, Joachim Nagel, referred to inflation as a “very greedy beast,” and the Chair of the U.S. Federal Reserve, Jerome Powell, stated that further rate hikes remained a probable course of action, despite the recent pause.
The Bank of England maintained its existing guidance on future policy, stating that if evidence of sustained pressures emerged, additional monetary tightening would be necessary.
The central bank also noted the significant increase in short-term British government bond yields, which projected an average Bank Rate of 5.5% over the next three years.
Additionally, the Bank of England expressed its intention to monitor the impact on mortgage costs and the rising expenses in the British rental market.
Official figures released on Wednesday indicated that consumer price inflation remained unchanged at 8.7% in May, while underlying inflation reached its highest level since the 90s.
