Vuk Valcic | SOPA Images | LightRocket | Getty Images The Bank of England voted to raise its key interest rate to 2.25% from 1.75% on Thursday, lower than the 0.75 percentage point hike many traders had expected. Inflation in the UK eased slightly in August, but at 9.9% year-on-year it remained well above the bank’s target of 2%. Energy and food have seen the biggest price increases, but core inflation, which strips these items out, is still at 6.3% year-on-year. The BOE cut its key interest rate, known as the Bank Rate, to 0.1% in March 2020 in an effort to support growth and spending at the start of the coronavirus pandemic. However, as inflation began to rise sharply late last year, it was among the first major central banks to begin a hiking cycle at its December meeting. This is its seventh consecutive rise and takes UK interest rates to a level last seen in 2008. In a statement explaining its decision, the bank noted volatility in wholesale gas prices, but said announcements of government caps on energy bills would limit further increases in consumer price index inflation. However, it said there had been further evidence since August of “continued strength in domestic inflation”. He adds: “The labor market is tight and pressures on domestic costs and prices remain elevated [energy bill subsidy] reduces inflation in the short term, it also means that household spending is likely to be less weak than predicted in the August Report over the first two years of the forecast period.’ Five members of the Monetary Policy Committee voted in favor of a 0.5 percentage point increase, while three voted in favor of a higher 0.75 percentage point that many had expected. One member voted for a 0.25 percentage point increase. The bank said it was not on a “predetermined path” and would continue to assess the data to decide the scale, pace and timing of future changes to the Bank Rate. The committee also voted to start the sale of UK government bonds held in its Asset Purchase Facility shortly after the meeting and noted a “sharp rise in government bond yields worldwide”. The bank’s decision comes against a backdrop of an increasingly weak British pound, recession forecasts, the European energy crisis and a program of new economic policies to be introduced by new prime minister Liz Truss. Sterling hit new multi-decade lows against the dollar this week, trading below $1.14 by Wednesday and falling below $1.13 early Thursday. It has fallen sharply against the dollar this year and was last at that level in 1985. It rose 0.2% after the BOE decision with the 0.5 percentage point rise fully priced in. The pound’s depreciation has been caused by a combination of dollar strength – as traders flock to perceived safe-haven investments amid global market volatility and as the US Federal Reserve raises its own interest rates – and gloomy forecasts for the UK economy. Many analysts, along with the business association British Chambers of Commerce and the BOE itself, have said they expect the UK to enter recession before the end of the year. In addition to energy price shocks, it faces trade barriers due to Covid-19 and Brexit, falling consumer sentiment and falling retail sales. Meanwhile, the country’s newly formed government has presented several major economic policy proposals this month ahead of a “fiscal event”, called a mini-budget, when they will be officially announced on Friday. This is expected to include reversing the recent rise in National Insurance tax, tax cuts for businesses and home buyers and a plan for low-tax “investment zones”. Truss has repeatedly emphasized his commitment to cutting taxes in an effort to stimulate economic growth. But the energy crisis also means the government has announced a massive spending package to curb soaring bills for households and businesses. Figures released on Wednesday showed the UK government borrowed 11.8 billion pounds ($13.3 billion) last month, almost double the forecast and 6.5 billion pounds more than the same month in 2019, due the increase in government spending. The UK is not alone in raising interest rates to fight inflation. The European Central Bank raised interest rates by 75 basis points earlier this month, while Switzerland’s central bank increased by 75 basis points on Thursday morning. The Federal Reserve raised its benchmark interest rate range by the same amount on Wednesday.
