By David Milliken and Andy Bruce
LONDON, Nov 3 (Reuters) – The Bank of England raised interest rates to 2.25 percent on Thursday, from 3 percent, its biggest hike since 1989 as it warned a “very difficult” perspective of the economy.
The central bank predicts inflation will hit a 40-year high of around 11% in the current quarter, but Britain is already in a recession that could last two years – longer than the 2008-09 financial crisis.
Thursday’s decision – the biggest in 33 years other than a failed attempt to prop up the pound on Black Wednesday in 1992 – was in line with economists’ expectations in a Reuters poll, but not unanimous.
Two politicians, Silvana Tenreyro and Swati Dhingra, voted for smaller increases of a quarter and a half percent, respectively, because the economy may already have been in recession.
But the majority of the Monetary Policy Committee said that rates should go even higher, although probably not as much as the 5.2% that was priced in financial markets when the BoE finalized its forecasts.
“For a sustained return of inflation to the target, a further increase in the Bank Rate may be necessary, albeit a lower peak than the financial markets are pricing,” the BoE said in a unique special guidance to investors.
Just before Thursday’s policy decision, markets were expecting rates to rise to around 4.75%.
“The committee continues to judge that, if the outlook suggests more sustained inflationary pressures, it will respond strongly, as necessary,” the MPC added.
Central banks across the Western world are responding to such challenges. Inflation has risen over the past year due to remaining labor shortages and supply chain disruptions due to the COVID pandemic and – in the European case – a large increase in energy bills since Russia invaded Ukraine in February.
The US Federal Reserve raised its key interest rate by 0.75 basis points to 3.75-4.0% on Wednesday, and the European Central Bank raised its deposit rate by the same amount last week to 1. 5% The Fed said future rate hikes may come in smaller steps.
The BoE has faced weeks of political and financial market turmoil since its last rate hike on September 22, as just a day later former prime minister Liz Truss’ government delivered an unfunded 45 billion pound ($52 billion) tax cut package. start off. a damning response from investors.
The policy was intended to stop the recession and stimulate long-term growth – but instead it pushed sterling to a record low against the US dollar, forced the BoE to freeze the bond market and led to Truss’s resignation.
Markets are now calmer, with British government borrowing costs broadly back to where they were before the turmoil. On Tuesday, the BoE was able to start selling bonds from its 838 billion pound stockpile of quantitative easing.
However, fundamental problems facing the British economy remain. Consumer price inflation returned to a 40-year high of 10.1% in September, and is likely to have risen last month as energy prices rose – despite costly subsidies to limit increases.
At the same time, the economy is slowing, as rising inflation limits consumer spending on non-essential goods.
The BoE estimates that the UK economy entered recession in the third quarter of 2022 and that the recession will continue until mid-2024, causing the economy to shrink by 2.9 percent. Unemployment will steadily rise to 6.4% by the end of 2025, down from 3.5% now, the lowest since the mid-1970s.
If the BoE does not raise rates further, the recession will be shorter – with a quarter of positive growth on average, and a cumulative loss of output of around 1.7%.
But inflation will be a little slower to fall, staying just above 2% in two years, compared to a lower rate if the BoE raises rates as much as markets previously expected.
BoE policy is particularly difficult due to the lack of clarity on future government policy.
While most of the Truss tax cuts have been ignored, new Prime Minister Rishi Sunak has indicated that there will be a need to clamp down on public spending and potentially higher taxes, the level of which will not be known until a budget statement on November 17.
Energy subsidies will stop in their current form in April, but the BoE has estimated in its forecasts that they will remain at about half their current size, avoiding a sharp rise in inflation next year.
(Reporting by David Milliken and Andy Bruce)
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Keywords: BOE/BRITISH DECISION
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