The Bank of England has shocked economists and investors by raising interest rates half a percentage point to 5% – the highest level since 2008.
Economists had expected the Monetary Policy Committee to raise interest rates by only a quarter percentage point, but the MPC voted 7-2 for the surprise increase, explaining that it was aiming to bring higher-than-expected inflation under control.
It comes after the UK’s official inflation rate failed to fall as expected in May, staying at 8.7% – well above the Bank’s 2% target.
In the minutes alongside the decision, the Bank said higher inflation, especially services inflation, meant it had to act faster to bring prices under control.
However, with other major central banks around the world now slowing the pace at which they’re increasing interest rates, the move will be seen as a further sign that Britain is becoming something of an outlier.
The UK has higher inflation than any other country in the G7 and is expected to see its interest rates peak higher than other major economies.
Markets expect the Bank to carry on raising borrowing costs in the coming months, with interest rates slated to peak at around 6% at the turn of the next year.
In its minutes, the Bank reiterated that “If there were to be evidence of more persistent pressures [in inflation], then further tightening in monetary policy would be required.”
Two of the MPC members, Swati Dhingra and Silvana Tenreyro, voted to leave interest rates on hold at 4.5%, warning that inflation was likely to fall rapidly in the coming months, and that the full impact of higher Bank interest rates had yet to be felt by the wider economy.
However the rest of the committee voted for the half percentage point increase – an increase which none of the economists recently surveyed by financial news outlets had expected.
“There had been significant upside news in recent data that indicated more persistence in the inflation process, against the background of a tight labour market and continued resilience in demand,” the minutes said.
Some will ask, however, whether this faster-than-expected increase will raise the chances of the UK tipping into recession in the coming months.
The Bank has yet to update its own forecasts to reflect this – that will happen next month.
Chancellor Jeremy Hunt said. “High inflation is a destabilising force eating into pay cheques and slowing growth.”
“Core inflation is higher in 14 EU countries and interest rates are rising around the world, but the lesson from other countries is that if you stick to your guns, you bring inflation down.
“Our resolve to do this is watertight because it is the only long-term way to relieve pressure on families with mortgages. If we don’t act now, it will be worse later”.