By David Milliken and Suban Abdulla
LONDON (Reuters) -The Bank of England raised interest rates by a bigger-than-expected half a percentage point on Thursday, after it said there had been “significant” news suggesting British inflation would take longer to fall.
The BoE’s Monetary Policy Committee (MPC) voted 7-2 to raise its main interest rate to 5% from 4.5%, the highest since 2008 and its largest rate increase since February, following stickier inflation and wage growth since policymakers last met in May.
“The economy is doing better than expected, but inflation is still too high and we’ve got to deal with it,” BoE Governor Andrew Bailey said after the decision. “If we don’t raise rates now, it could be worse later,” he added.
Economists polled by Reuters had expected a move to 4.75%, although financial markets earlier on Thursday had seen a nearly 50% chance of a rise to 5%, following higher-than-expected inflation data released on Wednesday.
Sterling briefly spiked higher against the U.S. dollar while two-year bond yields briefly dipped below 5% after the BoE decision. An inversion of the two-year to 10-year yield curve, often a sign that investors expect a recession, deepened.
Joseph Little, Global Chief Strategist at HSBC Asset Management, said Britain was in the worst position of major Western economies, hit not only by the cost of living crisis but also a shortage of workers and fast-rising wages.
“Inflation pressures show more persistency and more momentum than other western economies, and that forces the Bank into a hawkish corner,” Little said.
“Today’s statement has increased concerns of a much-higher terminal policy rate, perhaps as high as 6%.”
BoE policymakers had given little indication that a half-point rate increase was under consideration in the run-up to Thursday’s announcement.
“There has been significant upside news in recent data that indicates more persistence in the inflation process,” the MPC said. “Second-round effects in domestic price and wage developments generated by external cost shocks are likely to take longer to unwind than they did to emerge.”
MPC members Silvana Tenreyro and Swati Dhingra opposed the rate rise – as they have all others this year – saying that much of the impact of past tightening had yet to be felt, and forward-looking indicators pointed to steep falls in inflation and wage growth ahead.
Britain’s high inflation rate is also a problem for Prime Minister Rishi Sunak, who has pledged to halve the pace of price growth this year in an attempt to win back voter support ahead of a national election expected in 2024.
A spokesperson for Sunak said shortly before Thursday’s rates announcement that Sunak supported Bailey. Finance minister Jeremy Hunt said the BoE had his full support and “tackling inflation relentlessly must be the immediate priority”.
Bailey has been criticised by some lawmakers from Sunak’s Conservative Party for not acting sooner and more aggressively on inflation.
RATE EXPECTATIONS SURGE
Expectations for BoE rate tightening have surged in recent days – sharply raising the cost of new mortgages – and before Thursday’s decision financial markets expected the BoE’s Bank Rate to peak at 6% by the end of the year. By contrast, economists polled by Reuters last week saw a 5% peak.
Britain’s economy – which was hit by the shock of Brexit as well as the COVID-19 pandemic and the surge in gas prices caused by Russia’s invasion of Ukraine – has dodged a widely expected recession so far in 2023.
However, unlike most other big rich economies, output has barely recovered to pre-pandemic levels and growth this year looks set to be a minimal 0.25%, according to BoE forecasts last month.
The BoE’s rate increase follows the European Central Bank’s decision last week to raise rates by a quarter-point to 3.5%, and rate rises by the Swedish and Norwegian central banks earlier on Thursday.
While Britain faces a tricky inflation challenge as inflation has been slow to fall from the 41-year high of 11.1% struck last year, other central banks see challenges too.
Bundesbank President Joachim Nagel described inflation as a “very greedy beast” on Wednesday, and the U.S. Federal Reserve Chair Jerome Powell said further rate rises remained “a pretty good guess”, despite last week’s pause.
The BoE retained its previous guidance on future policy, which stated that if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.
The central bank also noted that short-dated British government bond yields had risen sharply – pricing in an average level of Bank Rate of 5.5% for the next three years.
The BoE said it would keep a close eye on the impact of higher rates on mortgage costs, as well as rising costs in Britain’s rental market.
Official figures on Wednesday showed consumer price inflation was unchanged at 8.7% in May and underlying inflation rose to its highest since 1992.
Last month the central bank forecast that inflation would fall to just over 5% by the end of this year and be below its 2% target in early 2025.
(Reporting by David Milliken and Suban Abdulla; Writing by William Schomberg; Graphics by Sumanta Sen; Editing by Catherine Evans)
