The Bank of England (BoE) raised its interest rates to the highest level since 2009 on Thursday to curb inflation, which will rise above 10% in the fourth quarter and cause the economy to contract.
The 0.25 point increase, the fourth consecutive increase decided by the British central bank, will bring the key rate to 1%.
Monetary Institute Governor Andrew Bailey acknowledged “the hardship this will cause for many people in the UK, particularly those on lower incomes, (…) who will be most affected by rising oil prices.” ‘.
The day before, the US Federal Reserve (Fed) had raised its key rate by 0.5 points, catching up to fight inflation compared to the BoE, which began trading in late 2021, while the European Central Bank (BCE ) plans to follow.
“Global inflationary pressures have risen sharply after Russia’s invasion of Ukraine” and will hit British households in October with a 40% rise in regulated electricity prices, the BoE said in the minutes of its meeting.
Result: Inflation is expected to peak at “just over 10%” in the fourth quarter, well above the UK monetary institution’s 2% target, and the economy is contracting as household purchasing power declines from late 2022.
These announcements caused the pound to fall more than 2% to $1,2360 around 15:15 GMT.
“The message is that there will be a need for a less harsh monetary policy to calm inflation than the market had anticipated,” with slow activity growth slowing price increases, said Daniel Vernazza, an economist at UniCredit.
The market expected an interest rate hike to 2.5% next year. But for the BoE, raising interest rates would weigh on activity so much that it would simultaneously choke inflation, which would fall well below its target of 2% by 2024.
In February, the BoE expected another 1.25% gross domestic product (GDP) increase in 2023. Now it expects a 0.25% contraction next year.
Given the way the UK’s electricity market is regulated, with changes occurring twice a year, “consumer price inflation may fall (…) later” than elsewhere in the world, the BoE warns.
If prices remain at high levels, “this will inevitably weigh on real household incomes in the UK and the margins of established companies there,” the BoE warns.
“Monetary policy can’t help this,” she adds, believing that “its role is to make sure this change happens in a way that’s compatible with the 2% inflation target.”
For the monetary institution, the challenge is to prevent these shocks from translating into long-term price and wage increases.
“Most committee members believe that a further increase in the coming months could be appropriate,” the minutes said.
The topic of the cost of living is at the center of local elections to be held in the UK on Thursday, with Prime Minister Boris Johnson pledging to ‘do everything’, while the opposition scoffs at his ‘out of touch’ approach.
The union’s general secretary, Sharon Graham, on Thursday denounced the rate hike, which she says is putting “financial pressure on ordinary families, on loans and rents.”
The International Monetary Fund (IMF) had cut its forecast for the UK economy sharply down a few days ago, saying it expected the UK to experience the weakest growth in the G7 next year.