(To correct the planned reduction of the doctrine in paragraph 7 to 80 billion pounds from 100 billion pounds)
LONDON (Reuters) – The Bank of England raised its key interest rate to 2.25% from 1.75% on Thursday and said it would continue to “respond aggressively, as necessary” to inflation, despite the economy entering a recession.
The Bank of England estimates that the British economy will contract by 0.1% in the third quarter – due in part to the additional public holiday for Queen Elizabeth’s funeral – which, combined with lower production in the second quarter, fits the definition of a technical recession.
Economists polled by Reuters last week had expected a repeat of a half-point rate hike in August, but financial markets bet on a three-quarter point increase, the largest since 1989, barring a short, failed bid in 1992 to prop up sterling.
The Bank of England’s move follows the US Federal Reserve’s decision on Wednesday to raise its key interest rate by three-quarters of a percentage point, as central banks around the world grapple with post-COVID labor shortages and the impact of the Russian invasion of Ukraine on energy prices.
“If expectations point to further persistent inflationary pressures, including from strength in demand, the Committee will respond aggressively, as necessary,” the BoE said, using a similar wording for the months prior to its policy intentions.
The Bank of England’s Monetary Policy Committee voted 5 to 4 to raise rates to 2.25%, with Deputy Governor Dave Ramsden and external MPC members Jonathan Haskell and Catherine Mann voting for an increase to 2.5%, while new MPC member Swati Dhingra wanted a smaller hike to 2%.
The Monetary Policy Committee also voted unanimously to reduce the Bank of England’s 838 billion pounds of government bond holdings by 80 billion pounds over the next year, by allowing bonds to mature and through active sales, which will begin next month. This is in line with the goal I announced in August.
The Bank of England now expects inflation to peak at just under 11% in October, down from the 13.3% peak it projected last month, before Liz Truss won the Conservative Party leadership and became Britain’s prime minister with her promise of an energy fee cap and tax cuts.
The Bank of England said inflation will remain above 10% for a few months after October, before declining.
Consumer price inflation fell to 9.9% in July from a 40-year high of 10.1% in August, its first decline in nearly a year.
On Friday, new Finance Minister Kwasi Koarting will provide more details on the government’s fiscal plans, which could amount to more than £150 billion of stimulus.
The Bank of England said it would assess the implications for monetary policy at its November meeting.
However, he noted that capping energy prices, while reducing inflation in the short term, would boost pressures further.
Prior to the rate decision, financial markets had expected the BoE to raise rates to 3.75% by the end of the year, with a peak of 5% in mid-2023. Less than a year ago, BoE rates were at a record low of 0.1%.
The pound fell to its lowest level since 1985 against the US dollar after the Federal Reserve’s decision on Wednesday, although it held up better against the euro.