Bank of England hikes interest rates to combat decades-high inflation

A general view shows Bank of England (BoE) in the City of London on September 22, 2022. The Bank of England hiked its interest rate sharply again to combat decades-high inflation but warned the UK economy was slipping into recession. (Photo by Isabel INFANTES / AFP) via Getty Images)

Bank of England on Thursday (22) raised its key interest rate to 2.25 percent from 1.75 percent, saying it would continue to “respond forcefully, as necessary” to inflation, despite the economy entering recession.

The BoE estimates Britain’s economy will shrink 0.1 percent in the third quarter, partly due to the extra public holiday for Queen Elizabeth’s funeral, which combined with a fall in output in the second quarter would meet the definition of a technical recession.

“Should the outlook suggest more persistent inflationary pressures, including from stronger demand, the Committee will respond forcefully, as necessary,” the BoE said, using a similar form of words to previous months for its policy intentions.

The BoE’s Monetary Policy Committee voted 5-4 to raise rates to 2.25 percent, with Deputy Governor Dave Ramsden and external MPC members Jonathan Haskel and Catherine Mann voting for an increase to 2.5 percent, while new MPC member Swati Dhingra wanted a smaller rise to 2 percent.

The BoE now expects inflation to peak at just under 11 percent in October, below the 13.3 percent peak it forecasted last month, before Liz Truss won the Conservative Party leadership and became Britain’s prime minister with a promise to cap energy tariffs and cut taxes.

Inflation would remain above 10 percent for a few months after October, before falling, the BoE said. Consumer price inflation fell to 9.9 percent in July from a 40-year high of 10.1 percent in August was its first drop in almost a year.

The announcement came as new finance minister Kwasi Kwarteng today (23) is expected to give more detail about the government’s fiscal plans, which may amount to more than 150 billion pounds of stimulus.

The BoE said it would assess the implications of this for monetary policy at its November meeting. However, it noted that the energy price cap, while reducing inflation in the short term, would boost pressures further out.

Financial markets now see a roughly three-quarters chance that the BoE will raise the Bank Rate again to 2.75 percent at its next meeting in November. Before the decision, a rate of 3 percent was fully priced in.

“The Bank of England … continues to look like something of a laggard compare to international peers, which is likely to keep the pound under selling pressure,” said Luke Bartholomew, senior economist at investment company abrdn.