LONDON: The Bank of England raised interest rates to 0.5% on Thursday and nearly half its policymakers wanted a bigger increase to contain rampant price pressures which the British central bank warned would push inflation above 7%.
In a surprise split decision, four of the nine Monetary Policy Committee members wanted to raise rates to 0.75% in what would have been the biggest increase in borrowing costs since the BoE became operationally independent 25 years ago.
The majority, including Governor Andrew Bailey, voted for a 0.25 percentage point increase.
The pound briefly jumped above $1.36, its highest level since Jan. 20, and touched a two-year high against the euro. British government bonds sold off, with the 10-year yield at its highest since January 2019.
Bailey said investors should not assume the BoE was embarking on a long series of rate hikes and that there would be a trade-off between strong inflation and weakening growth as many households see their incomes squeezed.
Shortly before the BoE announcement, finance minister Rishi Sunak announced measures to help households cope with a leap in energy prices in April, when taxes for workers and firms are due to rise.
“The MPC judges that if the economy develops broadly in line with the February report’s central protection, some further modest tightening of monetary policy is likely to be appropriate in the coming months,” Bailey told reporters.
“But it would be a mistake to extrapolate simplistically from what we have done today and assume that rates are now on an inevitable long march upwards.”
Thursday’s move followed a rate hike in December, marking the first back-to-back increases in Bank Rate since 2004.
Suren Thiru, head of economics at the British Chambers of Commerce, said that, plus the four MPC members wanting a bigger increase, meant many would think the BoE was making “a leap towards a sustained period of significant monetary tightening”.
Investors were pricing in Bank Rate hitting 1.5% by the end of 2022 shortly after the BoE’s announcement.
The BoE said consumer price inflation - which stood at 5.4% in December - should peak at around 7.25% in April, which would be the highest rate since the recession-ravaged early 1990s and miles off its 2% target.
In contrast with the approach taken by the European Central Bank the BoE warned further “modest tightening” is in the pipeline, even though growth will be hurt by global energy and goods price inflation.
“Given the current tightness of the labour market and continuing signs of greater persistence in domestic cost and price pressures, all members of the Committee judged that an increase in Bank Rate was warranted at this meeting,” minutes of the BoE’s Feb. 2 meeting said.
High inflation meant post-tax income for working households would fall by 2% this year and 0.5% next year, while weakening demand would push unemployment up to 5% in three years’ time.
The BoE also said it will start to unwind its 895 billion pounds ($1.2 trillion) quantitative easing programme by allowing its vast holding of British government bonds to roll off its balance sheet as they mature. It will sell its much smaller stock of corporate bonds.
Price pressures look set to persist for much longer than forecast in November by the BoE, which trebled its forecast for wage growth this year to 3.75%.
Inflation in a year’s time now looks set to remain above 5% based on the market outlook for interest rates.
But in a sign the BoE thinks investors have priced in too many rate hikes, it predicted inflation in three years’ time would be below target at around 1.6%.
SPLIT DECISION
Bailey, his deputies Ben Broadbent and Jon Cunliffe, Chief Economist Huw Pill and external MPC member Silvana Tenreyro comprised the majority voting for a 25 basis point rate hike.
The BoE said they recognised the risks of strong price pressures but also the potential for inflation to fall faster than expected if global energy and goods costs ease as markets expect - rather than a more cautious BoE assumption.
They warned a larger rate hike could have an “outsized impact” on expectations for borrowing costs, which were already strong enough, if implemented, to push inflation below target in three years’ time.
Deputy Governor Dave Ramsden and external members Michael Saunders, Jonathan Haskel and Catherine Mann voted for a half-percentage-point rate rise to reduce the risk that recent pay growth and inflation expectations became more firmly embedded.
BOND SALES
The BoE said it would begin to unwind its asset purchases, accumulated over the last decade to help stimulate the economy, in a process known as quantitative tightening (QT)
This will start next month when a British government bond held by the central bank matures. The 27.9 billion pounds of proceeds will not be reinvested, the BoE said - and nor will future gilt redemptions, worth around 70 billion pounds over 2022 and 2023.
The BoE will consider actively selling gilts once Bank Rate hits 1%.
It also said it plans to reduce its 20 billion pounds of corporate bond holdings to zero no sooner than end-2023, through not reinvesting maturing bonds and a yet-to-be-announced sales programme.
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