The Bank of England raised its key interest rate for the third successive policy meeting, taking borrowing costs back to their pre-pandemic level and warning the war in Ukraine may push inflation well above 8 per cent later this year.
The increase to 0.75 per cent was backed by eight of the bank’s nine policy makers, with Deputy Governor Jon Cunliffe voting for no change. The move is the latest sign the U.K. is leading the way in a global tightening of monetary policy, and makes it first major central bank to bring rates back to the settings before the coronavirus hit.
But officials led by Governor Andrew Bailey tempered the outlook by saying that a further tightening of policy “might be” appropriate in the coming months, a softening from the wording in February, when they said such a move was “likely.” They also warned the squeeze on households incomes in the U.K. will be “materially larger” than feared just six weeks ago.
That suggests that the committee expects an increasingly delicate balancing act in the coming months as it weighs both how to combat inflation and the growing threats to the economy from the impact of the war in Ukraine. Debate about a half-point rate rise that dominated the February meeting gave way to discussion about whether to hold off on further action.
Traders removed bets on a single 50 basis-point hike by June after the announcement, since none of hawks from February kept up their push for an outsized move. The pound reversed gains and yields on government bonds also dropped. Stocks extended gains.
“Markets may have got carried away with pricing in a total of five more rate hikes by the end of this year,” according to Yael Selfin, chief economist at KPMG UK. She expects two more rate rises this year but acknowledges that “we cannot rule out further increases if that risks de-anchoring inflation expectations.”
The central bank said inflation now looked set to climb to around 8 per cent in the second quarter, up from 7.25 per cent previously. It warned the peak rate later this year could be “several percentage points higher” than estimated in February. The BOE target is 2 per cent.
The action in the past three meeting marks the quickest pace of tightening since 1997, just after the BOE won the authority to set policy independently. The decision came just hours after the U.S. Federal Reserve raised interest rates by a quarter percentage point and signaled six more such hikes this year.
The spike in inflation will intensify the squeeze on household incomes, the central bank said. It also warned that the war in Ukraine will exacerbate global supply chain disruptions and said its regional agents found evidence it’s already snarling supply chains for manufacturers.
“The annual rise in household energy bills from April is set to be large, driving up consumer price inflation as well as squeezing real incomes by significant amounts,” Bailey wrote in a letter after the decision.
The cost of living crisis will lead to a weaker outlook for growth and raise unemployment, officials said. Cunliffe, in voting to leave rates unchanged, focused on that dynamic and concerns about the “very material negative impacts” that higher commodity prices will have on living standards.
For the rest of the committee, robust growth in recent months and a continued tightening in the labor market warranted a move. They said that job shortages were unlikely to ease as quickly as had been expected in February.
Further out, the BOE also said inflation will “fall back materially,” a comment that, combined with the gloomy outlook for living standards, suggests a degree of pushback against market pricing for rates to hit 2 per cent by the end of the year.
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