The Bank of England has raised interest rates by 0.5 percentage points to 3.5% in an effort to combat double-digit inflation that has caused a widespread cost of living crisis.
Members of the central bank’s monetary policy committee (MPC) voted to increase the cost of borrowing after the consumer prices index (CPI) in November showed annual inflation of 10.7%.
A majority of the Bank’s rate-setting committee said the ninth increase in the base rate over the last year was necessary to bring down inflation by 2025 to its 2% target.
The move takes UK rates to the highest level since October 2008, and comes despite expectations that the UK is falling into a long recession. However, it marked a slowdown in the pace of rate rises, after the MPC increased borrowing costs by 0.75 percentage points at its meeting in November.
The headline rate of UK inflation dropped in November to 10.7% from 11.11% in the previous month, but the drop was not enough to persuade the Bank to support a smaller increase while food and energy price rises remained strong.
Financial markets expected the rise, which was heavily trailed by the governor, Andrew Bailey, and the chief economist, Huw Pill, after they said “more needed to be done” to bring down inflation, but a repeat of November’s 0.75 percentage point rise was unlikely.
In a three-way split vote that recorded two members of the nine-strong MPC voting to keep the base rate on hold and another member push for a more aggressive rise, the MPC said there were “considerable uncertainties around the outlook”.
While global supply chain blockages have eased, bringing down the price of many commodities and goods since they rose sharply earlier this year, cost pressures have remained throughout the global markets.
With cold winter weather biting much of Europe, the path of gas prices and the cost of food could rise, keeping inflation higher for longer.
The US Federal Reserve and the European Central Bank have signalled that they will ease back on rate rises in 2023 following forecasts that there is a strong prospect of a recession and job losses across the industrialised world.
Russia’s invasion of Ukraine continues to disrupt the supply of gas and some foodstuffs, adding to inflationary pressures.
The Bank’s report said there were several indicators showing the economy had weakened since the summer. It expects a 0.1% contraction in GDP in the last quarter of 2022, which would put the UK economy officially in recession after a 0.2% contraction in the third quarter. The downturn is expected to last well into 2023.
The number of home purchases had fallen to below 60,000 a month, the lowest since 2013, giving a strong indication that the housing market is weakening.
Bank officials rely on regional agents to test the state of the business sector. A report by the Bank’s agents found that business investment had fallen in recent months and surveys of confidence among industry leaders showed they remained wary, though “mentions of uncertainty in the agents’ reports had fallen back somewhat in recent weeks”.
Two members of the MPC, the LSE professors Swati Dhingra and Silvana Tenreyro, said the cost of living crisis facing millions of households and interest rate rises already working their way into higher mortgage costs meant the economy would slow without further rate rises.
In comments relayed by officials in the Bank’s accompanying report, they said: “The lags in the effects of monetary policy meant the sizeable impacts from past rate increases were still to come through.
“That implied the current setting of [the base] rate was more than sufficient to bring inflation back to target in the medium term.”
Catherine Mann, a former chief economist at the US bank Citi, was reported to believe a 0.75 percentage point rise was needed to “reinforce the tightening cycle, importantly leaning against an inflation psychology that was embedding in wage settlements and inflation expectations”. She was outvoted.
Surveys of wage settlements across the private sector show they remain at 4%. Official data shows earnings rising at about 6%, although the figure is driven by strong increases in salaries across the financial and business services sectors.