London – The Bank of England (BoE) raised interest rates by the most since 1989 on Thursday, but it also warned that Britain faced a long recession and told investors borrowing costs were likely to go up by less than they expect.
The BoE increased bank rate to 3% from 2.25% even as it said Britain’s economy might not grow for another two years, a slump longer than during the 2008-09 financial crisis.
The pound sterling fell sharply and was down about 2% against the U.S. dollar, touching its lowest since mid-October when Britain was in a political crisis triggered by the tax-cutting plans of former prime minister Liz Truss.
On Wednesday, the U.S. Federal Reserve also hiked rates by 75 basis points, but signalled U.S. borrowing costs were likely to rise more than anticipated to crush inflation.
That contrasted with the BoE’s message on Thursday.
“We can’t make promises about future interest rates, but based on where we stand today, we think bank rate will have to go up by less than currently priced in financial markets,” BoE governor Andrew Bailey said, in an unusually blunt message.
The BoE said it now expected inflation will hit a 40-year high of around 11% during the current quarter. But it also thinks the economy entered a recession that could mean it contracts in both 2023 and 2024 and shrinks by 2.9% in total.
Unemployment would rise steadily to 6.4% by late 2025, nearly doubling from a current 3.5%, its lowest rate since the mid-1970s.
The rise in borrowing costs – the biggest in 33 years apart from a failed attempt to support the pound sterling on Black Wednesday in 1992 – was in line with expectations from economists, but it was not unanimous.
Two policymakers, Silvana Tenreyro and Swati Dhingra, voted for smaller increases of a quarter and half a percentage point respectively.
The majority of the nine-member Monetary Policy Committee (MPC) said rates will need to rise higher still, although probably not as high as the 5.2% that was priced into financial markets when the BoE finalised its forecasts.
“Further increases in bank rate might be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets,” the BoE said, offering unusually specific guidance to investors.
Earlier on Thursday, markets were expecting bank rate to peak at around 4.75%. After its announcement, that peak had fallen to under 4.7% in September next year.
“The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary,” the MPC added, echoing its previous guidance.
Central banks across the Western world are responding to similar challenges. Inflation has rocketed over the past year due to residual labour shortages and supply-chain bottlenecks since the novel coronavirus (COVID-19) pandemic and – in the case of Europe case – a big increase in energy bills since Russia invaded Ukraine in February.