Bank of England raises interest rates for the first time in a decade and signals more increases ahead

Decision aimed at dealing with inflation stoked by Brexit

PUBLISHED : Friday, 03 November, 2017, 2:03am
UPDATED : Friday, 03 November, 2017, 5:51am

The Bank of England raised interest rates for the first time in more than 10 years on Thursday and said it expected only “very gradual” further increases over the next three years.

The Boe said its nine rate-setters voted 7-2 to increase its benchmark Bank Rate to 0.50 per cent from 0.25 per cent, reversing the emergency cut made in August 2016, soon after the shock decision by British voters to leave the European Union.

It was the first time that the Boe increased borrowing costs since 2007, before the eruption of the global financial crisis, which tipped Britain into its deepest recession in decades.

However, sterling fell around a cent against the US dollar and government bond yields dropped by 5 basis points as markets homed in on the Boe’s cautious approach to future rate rises. The Boe did not repeat previous language about markets underestimating the extent of future rises.

Boe Governor Mark Carney said the sheer novelty of a first rate hike created some uncertainty about its impact on the economy, but there was no reason to expect it to be larger than normal. Domestic inflation pressures were likely to build, he said.

“It isn’t so much where inflation is now but where it is going that concerns us,” Carney said in a speech following the decision. But he added that even after the rate increase, monetary policy will provide significant support to jobs and activity.

The two Monetary Policy Committee members who voted to keep rates steady, deputy governors Jon Cunliffe and Dave Ramsden, shared the widespread view among economists outside the Boe that wage growth is too weak to justify a rate rise now.

But most MPC members, including Carney, decided it was time to start to tighten policy, despite the British economy’s sluggish performance this year.

“The MPC now judges it appropriate to tighten modestly the stance of monetary policy to return inflation sustainably to target,” the Boe said in a statement.

“All members agree that any future increases in Bank Rate will be at a gradual pace and to a limited extent,” it said, repeating its previous signals on what is likely to happen to borrowing costs.

The Boe said debt servicing costs paid by British households and companies would remain “historically very low” despite Thursday’s hike.

At its previous meeting in September, the Monetary Policy Committee had voted 7-2 in favour of keeping rates on hold. But it warned then that rates could rise “over the coming months”.

Bank of England’s chief economist believes rate rise needed to keep lid on inflation

Economists had overwhelmingly predicted a hike at November’s meeting, although nearly three-quarters of them thought it was too soon to make such a move, given the deep uncertainties about Brexit and weak wage growth.

“They’ve erred on the dovish side as far as the comments are concerned,” Craig Erlam, an analyst with brokerage OANDA, said.

George Buckley, an economist with Nomura, said there was still a chance that the Boe would raise rates more quickly than markets expect because it saw inflation slightly above its 2 per cent target over the next three years.

“They removed the comments about the need for rates to rise more quickly than the markets have been pricing in. But the sentiment is still there,” Buckley said.

The split on the MPC reflects the dilemma facing the central bank.

On the one hand, Britain’s economy has grown only slowly this year as a jump in inflation caused by the slump in the value of the pound after the Brexit vote pinched spending by consumers. Also, companies are offering sub-inflation pay increases to their staff.

The central bank said the decision to leave the EU was already having a “noticeable impact” on the economic outlook.

But it downgraded its estimate of how fast the economy could grow without generating excess inflation, justifying its decision to raise rates.

Consumer price inflation hit a five-year high of 3 per cent in September – mostly due to the fall in the value of the pound – and the Boe said it expected it to peak at 3.2 per cent in October. The lowest unemployment rate since the 1970s and an expected improvement in lacklustre productivity growth suggested pay growth was about to rise, the Boe added.

The Boe said it expected inflation to fall back to close to its 2 per cent target only if Bank Rate rose in line with the “gently rising” path implied in financial markets.

This would mean rates hit 1 per cent by 2020, with one increase of a quarter of a percentage point likely next year, according to detailed forecasts in the Inflation Report.

The Boe will be following the path taken by other central banks.

The US Federal Reserve has already raised rates from their post-crisis lows and the European Central Bank is signalling a shift away from its huge stimulus for the euro zone economy.

The Boe said it now expected Britain’s economy would grow by 1.6 per cent next year and by 1.7 per cent in 2019, unchanged from its forecast made in August and in line with a new, slower, sustainable rate. Before the financial crisis, Britain’s economy typically grew by more than 2 per cent a year.