The Bank of England raised interest rates by half a percentage point on Thursday, moderating the pace of increases while Britain braces for a prolonged recession with inflation eating away at household budgets.
The central bank predicted that the British economy is already in a recession and that inflation has peaked. Consumer prices rose 10.7 percent in November from a year earlier, data published on Wednesday showed. That was down slightly from 11.1 percent in October, the highest annual rate since 1981.
Even as Britain faces a challenging economic outlook, most of the bank’s nine-person rate-setting committee said that they expected more increases in interest rates will be needed to bring inflation back to the bank’s 2 percent target.
The Bank of England started raising rates a year ago and over the course of nine consecutive policy meetings the bank has lifted rates from 0.1 percent to 3.5 percent, the highest since 2008. In November, it increased rates by three-quarters of a point.
“There were considerable uncertainties” around the economic outlook, according to the minutes of the bank’s meeting. “If the outlook suggested more persistent inflationary pressures” the committee that sets interest rates would “respond forcefully.”
Higher energy prices, especially since Russia’s war in Ukraine began earlier this year, have been heavily responsibly for the sharp increase in inflation in Britain. But the central bank has grown more concerned at the extent to which high prices have seeped into the British economy, with service businesses setting higher prices and wages rising quickly.
The bank said that the labor market remained tight and inflationary pressures in the British economy could make large price increases more persistent, as it continued to raise interest rates despite the grim economic outlook. In particular, service price inflation and wage growth in the private sector have been rising faster than the central bank expected. Before adjusting for inflation, private-sector pay rose at an annual rate of 6.9 percent in the three months to October, data published on Tuesday showed.
“Inflation may be coming down but it would be premature” for the Bank of England “to claim victory in the fight over inflation,” Karen Ward, a strategist at J.P. Morgan Asset Management, wrote in a note. She added that she expects the bank to raise rates by at least another percentage point before stopping, arguing that the bank “needs to be extremely vigilant that a new high-inflation mentality does not take hold.”
The bank’s decision came a day after the Federal Reserve raised interest rates by half a percentage point, but the Fed chair, Jerome H. Powell, said that rates would climb higher than previously expected next year as inflation proves difficult to temper. Later on Thursday, the European Central Bank is expected to follow both the Fed and Bank of England in moderating its pace of rate increases to half a point, from three-quarters of a point.
But as the British economy slows and households contend with the highest food price inflation in more than four decades, combined with a jump in mortgage costs and higher energy bills, two members of the Bank of England’s committee voted to hold rates steady at this meeting. They said higher interest rates were already tightening financial conditions, and cited the weakness in the economy from incomes lagging far behind inflation.
“The lags in the effects of monetary policy meant that sizable impacts from past rate increases were still to come through,” Silvana Tenreyro and Swati Dhingra argued, according to the minutes of this week’s meeting, and so further interest rate increases weren’t needed for inflation to return to target. It was the first time since March that any committee members had voted to keep rates on hold.
The central bank’s forecasts show that the British economy is already in a recession, albeit a shallow one, with growth falling slightly this quarter after a 0.2 percent decline from July to September.
But the divergence in opinion was wide. One member of the committee, Catherine L. Mann, voted for another three-quarter-point increase, arguing that wage pressures would stay strong for longer than previously thought, and the bank should lean against “an inflation psychology” that was pushing up expectations of further price increases.
Since the central bank’s last meeting, the government announced a 55 billion pound ($68 billion) plan for higher taxes and spending cuts. Last month, Prime Minister Rishi Sunak and his top finance minister, Jeremy Hunt, said the measures were necessary as part of their efforts to bring down the nation’s debt and restore fiscal credibility after the short and turbulent premiership of Liz Truss.
The measures are expected to add 0.4 percent to gross domestic product over the first year, but have almost no impact on economic growth in the following year and shrink the economy in the third year as the spending cuts and tax increases start to bite, the bank forecast. The overall impact of these measures on inflation is expected to be small, it added.
