The central bank announced a new rate hike of 0.5 percent on Thursday.
(Photo: Bloomberg)
London The Bank of England (BoE) has raised interest rates in the UK by 50 basis points to 2.25 percent. This is the highest level since 2008. The central bankers had already increased borrowing costs by half a percentage point at the beginning of August. However, financial markets had expected more and priced in a 75 basis point increase. At the same time, the central bankers announced that they would gradually reduce their bond portfolio of £857 billion from October.
With their interest rate move, the British monetary authorities also lagged behind the example of their US colleagues, who decided on Wednesday to raise interest rates by 75 basis points. The European Central Bank (ECB) recently raised interest rates in the euro zone by the same amount.
The decision of the BoE’s monetary policy committee was not unanimous: three members voted for a larger interest rate hike, one central banker advocated a hike of only 25 basis points. However, BoE chief Andrew Bailey and four of his colleagues prevailed with their proposal for half a percentage point.
Central bankers said they would “react vigorously” should inflationary pressures prove more intractable. They also pointed out that renewed inflationary pressures could come from stronger demand. A nod to the government’s energy aid, which will pump an additional £150 billion (€172.5 billion) into the economy. Nevertheless, the BoE still expects a recession and expects that the British gross domestic product (GDP) will fall slightly in the third quarter of the current year.
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The interest rate differences between the major economic regions have a major impact on exchange rates. With the British pound falling to its lowest level against the dollar in almost 40 years and losing further ground after the interest rate decision, the British monetary authorities are under pressure to act to stabilize the currency’s external value. After all, a weak currency means that imports become more expensive and thus domestic inflation continues to heat up.
While the pace of price increases for UK consumers slowed slightly in August, the inflation rate at 9.9 percent was still five times the BoE’s target. The central bankers assume that inflation will increase again in the coming months and could peak at around eleven percent.
Government’s emergency budget could reignite inflation
The government price cap that the new government in London installed on October 1 is likely to have a dampening effect on the enormous price increases for electricity and gas. There will then be a price cap on electricity and gas to ensure that the energy bill for an average household does not exceed £2,500 (€2,875) a year over the next 24 months.
The government wants to cover the difference between the state-controlled prices and the actual market prices with new loans. The details of this will be announced by the new finance minister, Kwasi Kwarteng, in an emergency budget on Friday. UK monetary authorities are concerned that the additional government spending could put inflationary pressures back on the table in the medium term.
“Even if the imminent risk of recession diminishes next winter, significant fiscal stimulus increases the risk that high inflation will persist for longer – and thus the likelihood that the Bank of England will eventually have to adopt significantly tighter policy,” Sandra said Horsfield, economist at financial services firm Investec.
More: Fed raises key interest rate by 0.75 percentage points – “job market out of balance”