LONDON – The Bank of England (BOE) raised interest rates by 75 basis points to 3 per cent on Thursday, its biggest rate rise since 1989, and said it thinks the British economy has already entered a recession that could last two years longer than during the 2008-2009 financial crisis.
The pound slid briefly below US$1.12 after the decision as the central bank said it might raise interest rates again because of a very challenging economic outlook.
But it pushed back against expectations for further steep hikes, saying Britain faces a long and painful recession.
The BOE forecasts inflation will hit a 40-year high of around 11 per cent during the current quarter.
Thursdays rise in borrowing costs the biggest in 33 years apart from a failed attempt to support the pound on Black Wednesday in 1992 was in line with economists expectations in a Reuters poll, but was not unanimous.
Two policymakers voted for smaller increases of a quarter and half a percentage point respectively, as the economy was probably already in recession.
But the majority of the nine-member Monetary Policy Committee (MPC) said rates would need to rise higher still, although probably not as high as the 5.2 per cent that was priced into financial markets when the BOE finalised its forecasts.
Further increases in (the) bank rate might be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets, the BOE said in an unusually specific guidance to investors.
Just before Thursdays policy decision, markets expected rates to peak at around 4.75 per cent.
The committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary, the MPC added.
Central banks across the Western world are responding to similar challenges.
Inflation has rocketed over the past year due to residual labour shortages and supply chain bottlenecks since the Covid-19 pandemic and in Europes case a big increase in energy bills since Russia invaded Ukraine in February.
The United States Federal Reserve raised its key interest rate, also by 0.75 percentage point, on Wednesday to a range of 3.75 per cent to 4 per cent, and the European Central Bank increased its deposit rate by the same margin to 1.5 per cent last week.
The Fed said future rate rises might come in smaller steps.
Britains finance minister Jeremy Hunt said the governments number one priority is to grip inflation, and today the Bank has taken action in line with their objective to return inflation to target. More On This Topic Sunak, Hunt say inevitable all Britons will pay more tax Britain's 'word of the year': Permacrisis Weeks of turmoil
The BOE has faced weeks of political and financial market chaos since its last rate rise on Sept 22.
Just a day later, former prime minister Liz Truss government launched an unfunded 45 billion (S$71.5 billion) package of tax cuts that received a damning response from investors.
The policy was aimed at staving off recession and spurring long-term growth, but instead it pushed sterling to a record low against the US dollar, forced the BOE to prop up the bond market and led to Ms Truss resignation.
Markets are now more stable, with British government borrowing costs broadly back to where they were before the turmoil.
On Tuesday, the BOE was able to begin selling bonds from its 838 billion quantitative easing stockpile.
But the fundamental problems facing the British economy remain.
Consumer price inflation returned to a 40-year high of 10.1 per cent in September, and is likely to have risen further last month when regulated energy prices rose, despite costly subsidies to limit the increase.
At the same time, the economy is slowing sharply, as soaring inflation limits consumer spending on non-essential items. More On This Topic UKs growth plan is dead as PM Sunak pivots towards spending cuts Britons skipping meals in cost of living crisis The BOE estimates that Britains economy entered recession in the third quarter of 2022 and that the recession will last until the middle of 2024, causing the economy to shrink by 2.9 per cent.
Unemployment would rise steadily to 6.4 per cent by late 2025, up from 3.5 per cent now, its lowest since the mid-1970s.
If the BOE does not raise rates further, the recession would be shorter with a quarter of positive growth in the middle, and a cumulative loss of output of around 1.7 per cent
But inflation would be slightly slower to fall, remaining just above the BOEs 2 per cent target in two years time, compared with some way below if it raises rates as much as markets had previously expected.
The BOEs policymaking is made especially tricky by a lack of clarity over future government policy.
While most of Ms Truss tax cuts have been reversed, new Prime Minister Rishi Sunak has indicated there will be a squeeze on public spending and potentially higher taxes, the scale of which will not become clear until a fiscal statement on Nov 17.
Energy subsidies are due to cease in their current form in April, but the BOE in its forecasts assumed they would continue at roughly half their current size, avoiding a sharp further rise in inflation next year. REUTERS More On This Topic Sunak faces dose of reality as economic and political woes mount Sunak eyes as much as $81.5b of British spending cuts, tax rises