The Bank of England has raised interest rates from 0.1 per cent to 0.25 per cent in its first increase in more than three years, saying that the risks of inflation required it to take pre-emptive action even as the UK is engulfed by the Omicron wave of coronavirus.
Surprising financial markets on Thursday for the second consecutive month and voting 8-1 in favour of higher interest rates, the bank’s Monetary Policy Committee decided it could no longer wait before seeking to cool spending in the economy.
The BoE said that the strength in the labour market and signs that inflation was becoming more persistent were enough to require an immediate tightening of monetary policy in order to bring inflation down in the medium term.
Further “modest” rises in interest rates would still be needed in the months ahead, the MPC said, to keep inflation under control and bring it down to the BoE’s 2 per cent target.
The pound climbed following the BoE decision, gaining 0.8 per cent against the dollar to trade at $1.337, its strongest level in three weeks.
The MPC said that the Omicron wave of coronavirus would knock the economy at the end of this year and in the first quarter of 2022, but the effects of the new variant on inflation were unclear.
Justifying its decision, the majority on the MPC said: “The labour market was tight and had continued to tighten, and there were some signs of greater persistence in domestic cost and price pressures.
“Although the Omicron variant was likely to weigh on near-term activity, its impact on medium-term inflationary pressures was unclear at this stage,” it said.
With the BoE’s peak inflation forecast rising from around 5 per cent in April 2022 to a new forecast of about 6 per cent, the vast majority of the MPC felt they had to take immediate action to stop inflation becoming entrenched in companies’ pricing policies and wage demands.
The majority on the MPC said there was some value in waiting longer to see the impact of the Omicron variant, but this was outweighed in their thinking by “a strong case for tightening monetary policy now, given the strength of current underlying inflationary pressures and in order to maintain price stability in the medium term”.
It added that there were likely to be more interest rate rises to come although these would not be rapid. “The committee continued to judge that there were two-sided risks around the inflation outlook in the medium term, but that some modest tightening of monetary policy over the forecast period was likely to be necessary to meet the 2 per cent inflation target sustainably,” the MPC said.
Mohamed El-Erian, president of Queens’ College, Cambridge university, praised the BoE’s early rate rise as a move to quell inflationary pressures that had become persistent and showed that “among central banks, the BoE has been ahead in understanding inflation dynamics and their implications for policy”.
The MPC voted unanimously to end its quantitative easing programme as planned at the end of this month, having accumulated created £895bn to purchase mostly UK government bonds.
Source: Economy - ft.com
