Bank of England increases interest rates by 0.5 percent to 4%

The central bank predicts a milder recession after rates have reached their peak and suggests that they may be at an earlier point.The Bank of England has increased interest rates by half a percentage point to a 15-year high of 4 per cent, but suggested they may have peaked.

The BoE, which now anticipates a milder recession than originally thought, stated that further increases would only be necessary if there are new signs that inflation is going to remain too high.

Pantheon Macroeconomics’ chief UK economist Samuel Tombs stated that the BoE’s current expectations for declining inflation indicate that it “does not intend to raise rates any further”.

Although the bank no longer stated that it would be required to act “forcefully”, Andrew Bailey, governor of the BoE, cautioned that they still had to make sure inflation was under control.

The Monetary Policy Committee voted 7 to 2 in favor of the 10th consecutive rate rise. This came just a day after a quarter point rise by the US Federal Reserve, and before the European Central Bank’s 0.5 point increase.

The ECB stated it would “stay in the course” regarding rate increases, but the BoE statement suggested that interest rates could peak at the new rate 4 percent, which is below the 4.5 percent expected by financial markets.

The MPC stated that “if there was to be further evidence of persistent [inflationary] pressures then further tightening of monetary policy would be necessary.”

Sterling fell on Thursday. It traded 0.45 percent lower against the euro at EUR1.12 while 0.36 percent against the dollar at $1.23.

As the debt price rose, the yield on the 10-year gilt fell 0.13 percentage point to 3.17 percent. Just after noon, London’s FTSE 100 saw an increase of 0.5%.

The BoE did not attempt to suggest that financial markets were misled in anticipating interest rate cuts later in the year. MPC members however warned that inflation risks are tilted significantly to the positive.

According to the BoE’s central inflation forecast, price increases will slow from December’s 10.5 percent annual rate to below 4% by the end. The BoE expects inflation to fall well below its 2 percent target for 2024.

Bailey explained why the BoE increased rates despite these predictions and said, “We need to be absolutely certain that we are turning the corner in inflation.”

Swati Dhingra, and Silvana Tenreyro (two of the MPC’s dissenting voices), voted to keep interest rates at 3.5%. They argued that Thursday’s rise to 4% “would bring forward the point where recent rate increases would have to be reversed”.

The BoE forecasts were less optimistic than its November predictions. The BoE now believes wholesale gas prices will drop and that companies won’t be reluctant to lay off employees in difficult economic times.

Although the central bank now predicts a mild recession it also stated that it believes UK’s economic performance will be weak for some time.

The fourth quarter of this year’s gross domestic product is expected to shrink by 0.7% compared to the same period in 2022. This is slightly more optimistic than the IMF’s forecast of a 0.5% decline in UK GDP for the same period.

BoE officials believe that the UK’s economy can not expand at 1 percent annually without inflicting inflationary pressures, after considering the possible shortage of workers, low investment by businesses, and trade weakness.

The equivalent sustainable annual growth rate before 2007-8’s financial crisis was 2.5%, and it was 1.5% prior to the coronavirus pandemic. The BoE blamed the economic weakness over the long-term to Brexit, the energy crisis and the pandemic.

According to the BoE, the downgrade means that the BoE expects that the output will be no lower at the beginning of 2026 than at the time of the pandemic at 2019’s end.

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