The Bank of England hiked its base rate to 2.25% from 1.75% on Thursday, lower than the 0.75 percentage point increase that had been expected by many traders, but cautioned the UK economy was already entering recession since GDP is forecast to contract by 0,1% in the third quarter, following on a 0.1% decline in the second quarter.
Inflation in UK dipped slightly in August but at 9,9% in the last twelve months remained well above the bank’s 2% target. Energy and food have seen the biggest price rises, but core inflation, which strips out those components, is still at 6.3% on an annual basis.
The BOE now expects inflation to peak at just under 11% in October, down from a previous forecast of 13%.
UK business associations and the British Chambers of Commerce have previously said they expect UK to enter a recession before the end of the year. As well as energy price shocks, it faces trade bottlenecks due to Covid-19 and Brexit, declining consumer confidence and falling retail sales.
The BOE dropped its key rate, down to 0.1% in March 2020 in an attempt to prop up growth and spending at the onset of the Coronavirus pandemic. However, as inflation began to rise sharply late last year, it was among the first major central banks to kick off a hiking cycle at its December meeting.
This is its seventh consecutive rise and takes U.K. interest rates to a level last seen in 2008.
In a release explaining its decision, the bank noted volatility in wholesale gas prices but said announcements of government caps on energy bills would limit further increases in consumer price index inflation. However, it said there had been more signs since August of “continuing strength in domestically generated inflation.”
It added: “The labor market is tight and domestic cost and price pressures remain elevated. While the [energy bill subsidy] reduces inflation in the near term, it also means that household spending is likely to be less weak than projected in the August Report over the first two years of the forecast period.”
Five members of the BOE Monetary Policy Committee voted for the 0.5 percentage point rise, while three voted for a higher 0.75 percentage point increase that had been expected by many. One member voted for a 0.25 percentage point hike.
The bank said it was not on a “pre-set path” and would continue to assess data to decide the scale, pace and timing of future changes in the bank rate. The committee also voted to begin the sale of U.K. government bonds held in its asset purchase facility shortly after the meeting and noted a “sharp increase in government bond yields globally.”