Bank of England raises UK interest rates and warns of 10% inflation

Governor of the Bank of England (BoE) Andrew Bailey
Governor of the Bank of England (BoE) Andrew Bailey. Photo: Justin Tallis/Pool via Reuters

The Bank of England (BoE) has raised UK interest rates to 1%, the highest level in 13 years, as it battles to keep a lid on soaring inflation.

Despite worrying signs that the British economy is slowing, members of the Monetary Policy Committee (MPC) voted 6-3 on Thursday to increase the benchmark cost of borrowing for the fourth consecutive time.

Rates are now at their highest level since February 2009, when they were hiked during the recession that was caused by the 2008 financial crisis.

The three members that voted for an even more aggressive 50 basis point rise were Michael Saunders, Catherine Mann and Jonathan Haskel, citing concerns about rising pay growth.

Since the start of the pandemic, when interest rates were brought to record lows of 0.1%, rates have been increased to 0.25%, 0.5%, and then 0.75% before Thursday’s decision.

Inflation hit a fresh 30-year high of 7% in the year to March on the back of soaring energy, fuel and food prices, well above the Bank’s 2% target. Households across Britain are now under mounting pressure from soaring living costs, exacerbated by Russia’s invasion of Ukraine.

Threadneedle Street is now expecting inflation to have accelerated in April after the energy price cap jumped 54%, warning the jump in consumer prices could reach as high as 10% later this year. Markets are bracing for a further surge in energy prices later in October.

UK inflation is currently at a 30-year high.
UK inflation is currently at a 30-year high.

The BoE added that the UK economy was also on course to shrink by 0.25% in 2023. The MPC said the UK will avoid a technical recession, but that output will collapse by close to 1% in the final quarter of this year as the cost-of-living crisis bites.

Meanwhile, in 2024 the British economy will stagnate with growth of just 0.25%.

"Prices are likely to rise faster than income for many people. That means that people will be able to buy less with their money. The UK economy has been recovering from the effects of COVID, but we expect the increased cost of living to lead to slower growth overall," the Bank said.

Other updates included that pay growth will hit 5.75% in 2022, much higher than February's forecast, before falling again in the following two years, while unemployment will drop this year before climbing to 5.5% by 2025.

Households are also facing a 1.75% decline in real disposable income this year, the second biggest fall since 1964.

Read more: How rising interest rates will impact your mortgage and savings

Some economists are now divided over the number of rate hikes the central bank will carry out in the months ahead.

According to the overnight index swaps (OIS) market ahead of the decision, traders are pricing in around six hikes including today’s move to lift the bank rate to around 2.25% by December whereas more prudent economists see interest rates moving a lot more slowly, reaching 1.5% by early 2023.

“UK inflation continues to run at a high level, so we should expect further rate hikes later in the year, with 25 basis point moves still the most likely course of action,” Chris Beauchamp, chief market analyst at IG, said.

“While this means the pound will remain under pressure vis-à-vis the US dollar, it allows the bank to proceed with its hiking policy without putting too much pressure on the economy, which remains in a weaker position than its US counterpart.”

The pound (GBPUSD=X) initially spiked at before the announcement before reversing gains to lose more than 1% to push below $1.25.

Read more: Bank of England: Russia-Ukraine crisis could drive UK inflation higher

It comes as central banks around the world have similarly started raising interest rates to combat runaway inflation. On Wednesday, the Federal Reserve lifted interest rates by 50bps, pushing the upper bound of the funds rate to 1%.

It was the biggest interest rate rise in 22 years, however, the US central bank played down any chance of a huge 75 basis-point lift in the near future.

It also laid out the start of the balance sheet reduction program starting with $47.5bn (£37.9bn) in June, rising to $95bn a month after 3 months.

Hinesh Patel, portfolio manager at Quilter Investors, said: “While the BoE may be putting up a confident front, given the current delicate market environment, we could easily see inflation continue to rise above the BoE’s forecasts. Investors will need to continue to watch the data and markets closely and allocate accordingly. Diversification, active management and prudency remain key.”

Watch: How does inflation affect interest rates?