Bank of England increases interest rates to 0.5% amid rising inflation

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The Bank of England (BoE) has increased interest rates to 0.5% as it warns on UK inflation and the rising cost of living.

The Monetary Policy Committee (MPC) voted 5-4 on Thursday to hike rates by a further 25bp (basis points) after it put rates up in December from record lows of 0.1% to 0.25%.

Four dissenting MPC members voted for a 50 basis point rise to 0.75%, arguing that monetary policy should tighten faster, to “reduce the risk that recent trends in pay growth and inflation expectations became more firmly embedded”, to help bring inflation down to target.

Governor Andrew Bailey, Ben Broadbent, Jon Cunliffe, Huw Pill and Silvana Tenreyro all voted for the rise to 0.5%, while Jonathan Haskel, Catherine L Mann, Dave Ramsden and Michael Saunders backed a 50 basis point rise to 0.75%.

The rate rise is the second increase since the start of the pandemic, and marks the first back-to-back hike since 2004.

The move was widely expected by economists, and markets now expect rates to hit 1% by May, previously expected by June, and 1.5% by September.

Before today’s decision, markets were not expecting rates to climb that high until early 2023.

“While the Bank of England has done as expected and raised rates, the big surprise is the sudden emergence of a hawkish constellation of policymakers that wanted to go further,” Chris Beauchamp, chief market analyst at IG Group, said.

“Clearly, at least some of the MPC are genuinely spooked by the direction of inflation and are worried about the bank becoming left behind by surging prices.”

The Bank also signalled that it will start winding down its £895bn ($1.3tn) stimulus package, which was introduced when the pandemic hit the UK economy, halting reinvestments on their gilt pile.

The Committee voted unanimously for the Bank to begin to reduce its £875bn stock of UK government bonds, by not buying new gilts when they mature. It also voted unanimously to reduce its £20bn stock of corporate bonds on its balance sheet, by not reinvesting maturing assets and by selling bonds.

It comes after UK inflation soared to a 30-year high in the year to December thanks to rising energy costs, strong demand for goods and services, and ongoing supply chain disruption.

According to the latest data from the Office for National Statistics (ONS), it climbed to 5.4%, the highest since the early 1990s. This was up from a decade-high of 5.1% in November, and is more than double the Bank’s 2% target.

Inflation is expected to soar to as much as 7.25% in April, when energy bills are set to rise. This is up from 5.4% in December, and more than three times the Bank’s target.

On Thursday, Andrew Bailey argued that the UK economic situation would be even worse without the central bank’s intervention, and that inflation is unlikely to return to the UK’s 2% target without interest rate hikes.

He admitted that the rate rise would hurt households but added that “he has no choice”.

“The big underlying drivers of this are things monetary policy can’t influence,” he said.

Bailey added: “Unfortunately, we’ve got a squeeze from energy prices, and you see the Ofgem announcement this morning, and in order to counter the threat, and the risk that we see of further pressure coming from the labour market, I’m afraid we do have to raise bank rates.

“This is a lot of pressure on households, and we have to be very clear, a lot of pressure on those households who are less able to afford it.”

Alpesh Paleja, CBI Lead Economist, said: “A rise in interest rates comes as no surprise. It’s likely that the Bank of England will tighten monetary policy again in the near future, with strong price pressures and further rises in inflation over the coming months a near-certainty.

“The resulting cost of living squeeze will hit the poorest households hardest, so it’s good to see the government taking steps to help the most vulnerable.

“But more broadly, it’s important that the Government sets higher longer-term ambitions for the economy, so that we break the current cycle of low underlying growth and higher taxes.”