The Bank of England has raised interest rates by 0.25 percentage points to 5.25 per cent, slowing the pace of increases amid signs persistently high inflation is beginning to ease.
The central bank’s Monetary Policy Committee voted by six to three on Thursday to take interest rates to a 15-year high, with two members preferring a larger 0.5 percentage point move and one voting to pause.
The MPC warned that borrowing costs were likely to need to remain elevated, judging that “it was too early to conclude that the economy was at or very close to a significant turning point”.
Inflation fell to 7.9 per cent in June and most economists had forecast a quarter-point increase after the central bank had raised rates by half a point at its last meeting.
Despite the decline in inflation, prices in the UK are rising at a faster pace than in other advanced economies such as the US, Japan and the eurozone, where hopes are rising that interest rates are close to a peak.
Sterling slipped and UK government bond yields fell after the BoE move. The pound fell slightly, extending earlier losses, to trade at a five-week low of $1.2623 against the dollar, down 0.7 per cent on the day.
Two-year UK government bond yields, which are highly sensitive to short-term interest rates, fell to 4.92 per cent from 4.94 per cent before the announcement.
The bank’s updated forecasts suggested that even if interest rates rise further, in line with recent market expectations, it will still take until mid-2025 for inflation to fall from its current level of 7.9 per cent to the BoE’s 2 per cent target.
The MPC said this was because it now saw evidence of a feedback loop developing between wages and prices, meaning that “some of the risks of greater persistence . . . had crystallised”.
Reiterating its previous guidance, the bank said further tightening of monetary policy would be needed if it saw evidence of more persistent inflationary pressures.
But in new wording, it also said it “would ensure that bank rate was sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target”.
It said that while the economy had shown “surprising resilience”, higher borrowing costs were now starting to take their toll on activity, with more definite signs emerging of the job market cooling and unemployment starting to rise.
The MPC’s new forecasts — based on higher interest rates and a stronger exchange rate than its May projections — show a weaker path for economic activity, with consumer spending slowing, business investment swinging from growth to contraction in 2024 and housing investment falling sharply.
The BoE said it expected GDP growth to remain steady at a quarterly pace of 0.2 per cent in the near term, but to weaken as the effects of higher interest rates add up.
However, it said the UK was likely to avoid a recession. It also expects inflation to continue falling in the near term, averaging 6.9 per cent in the third quarter of 2023 and 4.9 per cent over the fourth quarter. This implies the government narrowly meeting its target to halve inflation within the year.
The BoE’s forecast that inflation will fall below 5 per cent in the fourth quarter is good news for UK prime minister Rishi Sunak, who had promised to “halve inflation” to 5.4 per cent by the end of the year.
Jeremy Hunt, chancellor, said: “If we stick to the plan, the bank forecasts inflation will be below 3 per cent in a year’s time without the economy falling into a recession.”
“But that doesn’t mean it’s easy for families facing higher mortgage bills so we will continue to do what we can to help households,” he added.
Sunak and Hunt are eager to avoid a recession, particularly one that comes in a general election year.
However, as Hunt acknowledged, the likelihood of interest rates staying at high levels for some time will hit voters with mortgages in the run-up to next year’s expected vote.
Shadow chancellor Rachel Reeves said: “This latest rise in interest rates will be incredibly worrying for households across Britain already struggling to make ends meet.
“The Tory mortgage bombshell is hitting families hard, with a typical mortgage-holder now paying an extra £220 a month when they go to remortgage.”
Additional reporting by Tommy Stubbington in London
Source: Economy - ft.com
