Bank of England raises UK interest rates to highest level since 2008

The Bank of England raised its key interest rate by a quarter of a percentage point to 4.5 per cent on Thursday, taking borrowing costs to their highest since 2008 with its 12th consecutive rate rise, as it seeks to curb the fastest inflation of any major economy.

The central bank no longer predicts recession after it revised up its growth forecasts from gloomy numbers released in February, the biggest such improvement since it first published forecasts in 1997.

But it also now expects inflation to be slower to fall than it had hoped, mostly due to unexpectedly big and persistent rises in food prices.

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"If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required," the BoE said, retaining the same guidance on future actions that it had in February and March.

A Reuters poll last week showed most economists expected the BoE to keep rates on hold after a quarter-point rise in May, but interest rate futures before Thursday's decision priced in a 5 per cent peak for interest rates this autumn.

Policymakers voted 7-2 for May's increase, in line with economists' expectations for a Reuters poll as Monetary Policy Committee members Silvana Tenreyro and Swati Dhingra again expressed their opposition to further tightening.

The BoE was the first major central bank to start raising borrowing costs in December 2021, but it has been accused by critics of not moving aggressively enough as inflation headed towards a four-decade high of 11.1 per cent struck in October.

Last week, the US Federal Reserve and the European Central Bank both raised their benchmark borrowing rates by 25 basis points. While Fed Chair Jerome Powell hinted at a pause, ECB President Christine Lagarde said it was too soon to stop.

Britain's high inflation problem stems largely from its heavy dependence on imported natural gas for power generation, leaving it particularly exposed to the surge in energy prices after Russia's invasion of Ukraine last year.

Energy prices have now fallen sharply and the central bank expects inflation to drop to 5.1 per cent by the end of this year from 10.1 per cent in March. But this is less of a decline than the drop to 3.9 per cent it forecast in February and the BoE predicts inflation will not return to its 2 per cent target until early 2025.

Higher forecasts for food prices had added about 1 percentage point to future inflation compared with February, the BoE said.

Most BoE policymakers see "significant" upward risks to these inflation forecasts. Taking this into account, inflation is not forecast to significantly undershoot its target at any point in the next few years, even if interest rates rise by a further quarter point or more.

The BoE is worried that recent strong headline pay growth could turn into a long-lasting problem for the economy.

"Pay rates could plateau at rates above those consistent with the 2 per cent inflation target sustainably in the medium term," the central bank said.

BoE chief economist Huw Pill said last month that British businesses and individuals had to accept that their earnings had fallen in inflation-adjusted terms, triggering a wave of criticism from trade unions and some former BoE rate-setters.

The BoE forecast the economy would grow 0.25 per cent this year - compared with its February prediction of a 0.5 per cent contraction.

Cheaper energy, fiscal stimulus and improved business and consumer confidence mean the BoE now no longer predicts recession this year and expects the economy to be 2.25 per cent larger in three years' time than it did before.

The government's budget announced in March was expected to boost economic output by around 0.5 per cent over the coming years.

The BoE estimated that around a third of past interest rate hikes had fed through to households and businesses, a slower pass-through than in previous tightening cycles because of a higher share of homeowners with fixed-rate mortgages.