Bank of England lifts interest rates to 0.5%

The Bank of England is expected to raise interest rates once again, adding pressure to household budgets as prices continue to rise.

The Bank of England has raised interest rates to 0.5 per cent in its first back-to-back rate rise for 17 years in an attempt to get a grip on soaring prices.

The monetary policy committee was divided on whether to raise rates by 0.25 percentage points or by even more, with five members, including the governor Andrew Bailey, voting to increase rates to 0.5 per cent and the other four opting for a bolder raise of 0.5 percentage points to 0.75 per cent.

The ratesetters said that a rise was needed to deal with “continuing signs of greater persistence in domestic cost and price pressures”.

The five members who voted to increase rates by 0.25 percentage points said that they recognised the risks of wage and price pressures in the short term but that these risks had to be balanced with the “potential for inflation to fall more quickly and to a greater extent than expected if energy and other tradable goods prices followed a lower path than in the MPC’s central projection”, according to the meeting minutes. They added that increasing rates by a larger increment could have a greater impact on market expectations for future rate rises.

The four who voted to raise rates by 0.5 percentage points said that a more significant tightening of monetary policy at this meeting would “reduce the risk that recent trends in pay growth and inflation expectations became more firmly embedded and thereby help to bring inflation back to the target sustainably in the medium term”.

The FTSE 100, which was trading slightly down at 7582.15 before the announcement, edged lower to 7562.69. Although banking and financial stocks, which will benefit from a rise, gained. The pound strengthened against the dollar and the euro to $1.3621 and €1.2055 respectively.

Interest rate rises are used by central banks to increase the cost of borrowing so as to suppress demand and, in theory, bring inflation back down to target.

Savers benefit from higher interest rates as they offer higher returns on savings; mortgage borrowers on variable interest rates face higher costs as interest rate rises are typically passed on in full by lenders in the next monthly bill. About 2.2 million people across the UK have variable mortgages.

At 5.4 per cent, the latest inflation figures for December are at almost three times the central bank’s target of 2 per cent. Unemployment levels are close to historic lows at 4.1 per cent and the number of vacancies is almost equal to the number of people jobless for the first time since comparable data was recorded more than twenty years ago.

The Bank was forced to revise up inflation projections for a fourth consecutive time, now expecting price growth to peak at a rate of 7.25 per cent in April, up from 5 per cent in its last quarterly projection made in November. The last time inflation was so high was in 1991, when it reached 7.9 per cent. Growth and unemployment projections were both revised down, with growth now expected to reach 3.75 per cent in 2022, down from 5 per cent, and the jobless rate expected to fall to 3.8 per cent. The committee expects inflation to remain above 5 per cent in a year’s time.

Officials said in their quarterly monetary policy report that the economy had been subject to “very large and repeated shocks” in the recent “unprecedented circumstances.

Take-home pay will fall by five times the amount it did during financial crisis of 2008, officials said. Rising global energy costs and goods prices, which are being pushed up by supply chain bottlenecks, will lead to a 2 per cent drop in households net income after inflation this year, the committee said. It is set to be the worst hit to real incomes since comparable records began in 1990. The only other time they contracted was in 2011, when real incomes fell by 1.3 per cent.

The committee predicts real wages to contract despite revising up its projections for wage settlements this year, up to almost 5 per cent. It expects the wage squeeze to peak in 2022 but to continue into next year.

Economic growth at the start of this year will be hit by the impact of Omicron restrictions but it is expected to return to pre-pandemic levels by March.

The monetary policy committee did not take into account the £350 cash available to the majority of households to pay for increased energy costs this year, as the briefing from the Treasury came in too late. The government funding, which was announced this morning, offers a £200 rebate on energy bills paid in October to be repaid over five years, beginning i April next year. Homes in the council tax bands A to D will also be paid a £150 cash rebate in April that they will not have to repay.

The MPC voted unanimously to reduce the stock of UK government bonds by ceasing to reinvest maturing assets, signalling a gradual end to quantitative easing. The Bank will also begin to sell its £20 billion holding of corporate bonds, which makes up a small proportion of its £895 billion total holding of assets. The committee said that it would not sell UK government bonds until the interest rate is at least at 1 per cent.

The minority who voted for a more aggressive rate rise to 0.75 per cent were Dave Ramsden, an internal member of the committee, and the external members Jonathan Haskel, Catherine Mann and Michael Saunders.

Financial markets had priced in a 100 per cent chance that the Bank would raise rates by 0.25 percentage points and some economists on the Times shadow monetary policy committee called for an even sharper rise of up to 0.75 per cent to offset expectations that a wage-price spiral could set in. A wage-price spiral is a cyclical process that occurs when high prices lead to demands for higher wages, which lead to businesses setting even higher prices to pay for the wage rises, thereby driving up inflation.

The monetary policy committee has never raised interest rates by more than 0.25 per cent in one go in its 25-year history.

The Bank of England became the first of the world’s large central banks to increase the cost of borrowing when it voted 8-1 to increase rates from a historic low of 0.1 per cent to 0.25 per cent in its December meeting.

Jerome Powell, chairman of the United States Federal Reserve, said after its January meeting that officials were “of a mind” to act soon and that there was room for further tightening of monetary policy without damaging employment levels.