Bank of England hikes rate to 5% in surprise move to tackle stubborn inflation

THE Bank of England (BOE) raised interest rates by a bigger-than-expected half a percentage point on Thursday (Jun 22) 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 per cent from 4.5 per cent, its highest since 2008 and its largest rate increase since February, following stickier inflation and wage growth since its policymakers met last in May.

“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,” it added.

Economists polled by Reuters had expected a move to 4.75 per cent, although financial markets earlier on Thursday had seen a nearly 50 per cent chance of a rise to 5 per cent, following higher-than-expected inflation data released on Wednesday.

BOE policymakers had given little indication that a half-point rate increase was under consideration in the run-up to Thursday’s announcement.

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.

Governor Andrew Bailey, in a regular letter to British Finance Minister Jeremy Hunt alongside the decision, reiterated most of the MPC statement.

“The MPC will do what is necessary to return inflation to the 2 per cent target sustainably in the medium term,” he said.

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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 per cent by the end of the year. By contrast, economists polled by Reuters last week saw a 5 per cent peak.

The BOE’s shock decision to raise borrowing costs a half percentage point divided business groups, consumer advocates and economists in their reaction.

While some have welcomed what appeared to be decisive action to combat sticky inflation, others claimed the UK central bank has condemned the nation to an unnecessary recession.

Few economists forecast a half point rise this week, though most calls were made before Wednesday’s unexpectedly high inflation print. Peter Kinsella, global head of foreign exchange strategy at Union Bancaire Privee, said the half point move “reeks of pure panic.”

“They have clearly disregarded their inflation forecasting framework and are now focused on backward looking data,” Kinsella said. “Today’s reaction says a lot – the pound weakened and gilt yields rose. It’s a classic emerging market style reaction.”

Joseph Little, global chief strategist at HSBC Asset Management, took the opposite stance. 

“Today’s decisive action comes at a critical moment for the UK economy,” Little said. “A ‘hawkish super-hike’ comes in the context of widespread recognition that UK policymakers need to ‘get ahead of the curve’.”

Goldman Sachs, which labelled the BOE a “reluctant hiker,” said in a note that the May decision may help stabilise volatile mortgage costs as it should “reassure markets somewhat that the BOE is prepared to raise rates as needed.”

Markets still expect rates to reach 6 per cent, but over a quicker period than projected before the rate decision. The reaction suggests the shock increase has not unsettled mortgage pricing any further. 

Mortgage rates have soared to near unaffordable levels on fears the BOE has not got inflation under control. Lenders have been pulling deals and aggressively raising rates due to market turbulence. 

However, Matt Thompson, head of sales at the estate agent Chestertons, warned that buy-to-let investors may now be forced to sell. Gary Smith, partner at wealth manager Evelyn Partners, warned the rate hike will cause “more mortgage market mayhem.” 

Businesses groups also expressed concern. 

“Interest rate rises are now causing worry for a rapidly growing number of firms, said Vicky Pryce, a member of the economic advisory council at the British Chambers of Commerce. “There should be absolutely no need to drive the economy into recession in a bid to deal with rising prices. Push too hard on interest rates and there is a real danger that more businesses will be driven to the wall, impacting the long-term outlook for economic growth and prosperity.” 

The Joseph Rowntree Foundation said: “This interest rate hike will have serious consequences for more than a million low-income mortgage holders going without essentials like food, clothes or unable to pay their bills.”

Raoul Ruparel, director of Boston Consulting Group’s Center for Growth, said, “The Bank of England finds itself firmly behind the curve and is playing catch up. It is increasingly difficult to see the path to inflation coming down in the UK without a recession.” REUTERS, BLOOMBERG