Bank Of England Raises Interest Rates To 15-Year-High Of 5% To Combat Inflation

The BoE's Monetary Policy Committee (MPC) voted 7-2 to raise its main interest rate to 5 per cent from 4.5 per cent, its highest since 2008 and its largest rate increase since February.  

This is the 13th interest rate hike in a row by the UK central bank even as US Federal Reserve decided to pause its monetary tightening policy earlier this month. 

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The Bank of England hiked its interest rate by 50 basis points to a 15-year high of 5 per cent on Thursday to combat stubbornly high inflation. The rate hike comes a day after the UK reported its inflation data for that month showing that inflation remained stubbornly high in May, at 8.7 per cent. This is the 13th interest rate hike in a row by the UK central bank even as US Federal Reserve decided to pause its monetary tightening policy earlier this month. 

The BoE's Monetary Policy Committee (MPC) voted 7-2 to raise its main interest rate to 5 per cent from 4.5 per cent, its highest since 2008 and its largest rate increase since February.  

"There has been significant upside news in recent data that indicates more persistence in the inflation process. Second-round effects in domestic price and wage developments generated by external cost shocks are likely to take longer to unwind than they did to emerge," the MPC said.

Bank of England's MPC members Silvana Tenreyro and Swati Dhingra opposed the rate hike decision, as they have consistently done throughout the year. They argued that the full effects of previous tightening measures were yet to be realized and forward-looking indicators indicated potential declines in inflation and wage growth.

On the other hand, BoE Governor Andrew Bailey echoed these sentiments in a letter to British finance minister Jeremy Hunt, aligning with the majority view expressed in the MPC statement.

"The MPC will do what is necessary to return inflation to the 2% target sustainably in the medium term," he said.

According to a report by Reuters, in the past few days, there has been a significant increase in expectations for the Bank of England to raise interest rates. This has led to a sharp increase in the cost of new mortgages. Prior to the recent decision, financial markets were anticipating that the Bank Rate would reach a peak of 6 per cent by the end of the year. 

As per the report, despite facing challenges such as Brexit, the COVID-19 pandemic, and the impact of Russia's invasion of Ukraine leading to a surge in gas prices, Britain's economy has managed to avoid a widely anticipated recession in 2023. However, unlike many other major economies, the country's output has only marginally recovered to pre-pandemic levels.

The Bank of England's forecasts from last month suggest that growth for this year is expected to be minimal, projected at 0.25 per cent, the report said. 

The BoE's rate increase follows the European Central Bank's decision last week to raise rates by a quarter-point to 3.5 per cnet, and rate rises by the Swedish and Norwegian central banks earlier on Thursday.

While Britain grapples with the challenge of a slow inflation decline from last year's 41-year high of 11.1 per cent, other central banks are also facing their own set of challenges. Joachim Nagel, the President of Bundesbank, referred to inflation as a "very greedy beast," highlighting the difficulties in taming it.

Meanwhile, Jerome Powell, Chair of the U.S. Federal Reserve, stated that despite the recent pause in rate hikes, the likelihood of further increases remains high.

On Thursday, the Bank of England maintained its previous stance on future policy, stating that if there are signs of persistent pressures, further tightening of monetary policy would be necessary. The bank also acknowledged the significant increase in short-term British government bond yields, which implies an average Bank Rate of 5.5 per cent over the next three years.

The Bank of England expressed its intention to monitor the impact on mortgage costs and the rising expenses in the rental market.

Official data on Wednesday showed that consumer price inflation remained unchanged at 8.7 per cent in May, while underlying inflation reached its highest level since 1992. In its previous forecast, the central bank predicted that inflation would decrease to slightly above 5 per cent by the end of this year and fall below its 2 per cent target in early 2025.