The Bank of England announced its seventh rate hike in less than a year on Thursday, despite forecasts of a recession, as it battles the highest level of inflation of any G7 economy.
The central bank repeated last month’s hike of half a percentage point, raising interest rates to 2.25% from 1.75%. It said it expected inflation to peak next month at 11 percent, lower than previously expected due to government intervention to subsidize energy bills.
“If the outlook suggests more persistent inflationary pressures, including from stronger demand, [monetary policy] The committee will respond strongly as necessary,” he added.
With Thursday’s move, the Bank of England has already raised the cost of borrowing for businesses and consumers to levels last seen in 2008 in a bid to ward off inflation that continues to hover just below 10%.
Like most of its major peers, the central bank must weigh the need to prevent runaway inflation and the damage caused by aggressive rate hikes.
Some economists believe that the UK economy is already in recession and the Bank of England shares this view. It forecast UK GDP to contract by 0.1% in the third quarter, partly as a result of the extra holiday for the Queen’s funeral. GDP fell so much in the second quarter.
The bank’s policymakers were split on how aggressive to be this month, with three members backing a three-quarter hike. But they voted unanimously to reduce the bank’s holdings of UK government bonds by £80 billion over the next 12 months in another move to tighten monetary policy.
Its deliberations were complicated by the weak pound, which fell to a new 37-year low against the US dollar on Wednesday. A weaker currency means the UK has to pay more for imported energy and food, increasing inflationary pressures on the economy.
The U.S. Federal Reserve on Wednesday announced a historic third consecutive three-quarter interest rate hike, adding further wind to the dollar’s sails. Benchmark US interest rates now range between 3% and 3.25%.
The European Central Bank also broke new ground with its decision earlier this month to raise eurozone interest rates from 0% to 0.75%. The Swiss National Bank on Thursday raised interest rates by three-quarters of a percentage point, taking them out of negative territory to 0.5%.
Further clouding the outlook for the Bank of England is a possible large increase in UK government spending to reduce the excessively high energy bills of businesses and households.
UK Finance Minister Kwasi Kwarteng will outline the cost of the subsidy program on Friday, but analysts have already estimated the bill could reach 150 billion pounds ($170 billion) over the next two years.
Combined with the tax cuts promised by new prime minister Liz Truss, they could keep inflation high for years to come and send UK government borrowing skyrocketing.
In a report published on Wednesday, the independent Institute for Fiscal Studies warned that the government risked putting Britain’s debt “on an unsustainable path”.
“At around 3.5% of national income, borrowing would not be twice the 1.9% of national income that averaged in the 60 years before the global financial crisis, when growth prospects were significantly higher,” he reported.
