Bank of England raises borrowing costs to 4%, hints rates near peak

The Bank of England raised interest rates for the 10th straight time on Thursday and signalled the tide was turning in Britain’s battle against high inflation, forcing investors to dial down bets on a more aggressive tightening of policy.

Softening their forecasts of recession this year, the BoE’s nine interest rate-setters voted 7-2 to increase Bank Rate to four per cent — its highest since 2008 — from 3.5 per cent. The move had been expected by most investors and economists.

The announcement comes a day after the US Federal Reserve slowed the pace of its rate hikes with a smaller quarter-point move, but said it expected further increases would be needed.

The European Central Bank raised rates by a half a percentage point on Thursday to 2.5 per cent.

The BoE — which is trying to smother the risks from Britain’s 10 per cent inflation rate without deepening the expected recession — said its run of rate hikes going back to December 2021 were likely to have an increasing impact on the economy.

That should help to bring inflation down to about four per cent by the end of this year, it said. Previously the BoE had forecast 2023 inflation at around five per cent.

“Since the November monetary policy report we’ve seen the first signs that inflation has turned the corner,” Governor Andrew Bailey said in a speech following the rate hike.

“But it’s too soon to declare victory just yet, inflationary pressures are still there.”

He said members of the central bank’s Monetary Policy Committee (MPC) would need to be “absolutely sure” that inflation was receding.

They said further interest rate hikes would hinge on evidence of more persistent price pressures appearing.

That represented a signal to investors that its sharp run of rate hikes might be coming to an end.

Previously the BoE had said it would “respond forcefully, as necessary” to signs of further inflation pressure, and that “further increases in Bank Rate may be required”.

The BoE sees inflation falling below its two per cent target in the second quarter of 2024, but it warned there were upside risks to this forecast from persistent labour market pressures and higher-than-expected core and domestically generated inflation.

After Thursday’s announcement, investors trimmed their bets that interest rates would peak as high as 4.5 per cent, in favour of an earlier halt at 4.25 per cent, while sterling and British government bond yields fell sharply after an initial spike.

“With inflation projected to ease sharply, today’s 50-basis point-rise should be the last of this magnitude. If we do slide into recession, then policymakers may be forced to reverse policy sooner than many expect,” said Suren Thiru, economics director at ICAEW, a professional body for accountants.

SHALLOWER RECESSION

The central bank said Britain was still on course for a recession but it was likely to be “much shallower” than it feared in its last forecasts in November, thanks largely to a fall in energy prices as well as lower market rate expectations.

Gross domestic product was now seen contracting by 0.5 per cent in 2023 compared with the 1.5 per cent shrinkage forecast in November and the recession would last five quarters — cutting output by less than one per cent — rather than eight quarters.

The BoE saw output shrinking in 2024 and barely growing in 2025, putting pressure on Prime Minister Rishi Sunak and his finance minister Jeremy Hunt, who has promised to set out measures to revive growth in a budget on March 15, ahead of a national election expected in late 2024.

The BoE’s new GDP forecast was similar to one published this week by the International Monetary Fund which said Britain’s economy would shrink by 0.6 per cent this year, while all the other Group of Seven nations were likely to grow.

Britain has been hit hard by the surge in energy prices after Russia’s invasion of Ukraine as it relies heavily on gas for power generation.

It has also suffered a fall in the size of its workforce that is believed to be linked to the coronavirus pandemic and post-Brexit restrictions on European Union workers.

The BoE said Britain’s lack of workers, combined with low business investment and weak productivity growth, meant the economy could probably only grow by about 0.7 per cent a year in the near term without generating inflationary heat.

Before the pandemic, the potential growth rate was about 1.7 per cent and Thursday’s downgrade represented a stricter speed limit on the economy, at least for the next couple of years while it recovers from the pandemic and the impact of Brexit.

As a result, the BoE saw Britain’s economy still below its pre-pandemic size until after 2025, representing seven lost years for growth. — Reuters

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