Bank of England raises rates again and warns inflation could break 8%

The Bank of England raised its key interest rate for the third successive policy meeting, taking borrowing costs back to their pre-pandemic level and warning the war in Ukraine may push inflation well above 8 per cent later this year.

The increase to 0.75 per cent was backed by eight of the bank's nine policymakers, with deputy governor Jon Cunliffe voting for no change.

It marks the quickest pace of tightening since 1997, just after the bank won the authority to set policy independently. But officials led by governor Andrew Bailey tempered the warning by saying that a further tightening of policy "might be" appropriate in the coming months, a softening from the wording in February, when they said such a move was "likely".

They also noted “there were risks on both sides of that judgment”. That suggests that the committee expects an increasingly delicate balancing act in the coming months as it weighs both how to combat inflation and the growing threats to growth from the impact of the war in Ukraine.

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Debate about a stronger response with a half-point increase that dominated the February meeting gave way to discussion about whether to hold off on further action. Traders removed bets on a single 0.5 percentage point hike by June after the announcement.

The pound reversed gains and yields on government bonds also dropped. Stocks extended gains.

"Markets may have got carried away with pricing in a total of five more rate hikes by the end of this year," according to Yael Selfin, chief economist at KPMG UK. She expects two more rate rises this year but acknowledges that "we cannot rule out further increases if that risks de-anchoring inflation expectations".

The central bank said inflation now looked set to climb to about 8 per cent in the second quarter, up from 7.25 per cent previously. It warned the peak rate later this year could be “several percentage points higher” than estimated in February. The Bank of England target is 2 per cent.

Federal Reserve

The UK is leading the way in a global tightening of monetary policy, and is the first major central bank to bring rates back to their pre-Covid setting. The decision came just hours after the US Federal Reserve raised interest rates by a quarter percentage point and signalled six more such hikes this year.

The spike in inflation means the squeeze on households incomes in the UK will be “materially larger” than implied in February, the central bank said.

It also warned that the war in Ukraine will exacerbate global supply chain disruptions and said its regional agents found evidence it’s already snarling supply chains for manufacturers. The squeeze on incomes will lead to a weaker outlook for growth and raise unemployment, officials said.

Mr Cunliffe, in voting to leave rates unchanged, focused on that dynamic and concerns about the “very material negative impacts” that higher commodity prices will have on living standards.

For the rest of the committee, robust growth in recent months and a continued tightening in the labour market warranted a move. They said that job shortages were unlikely to ease as quickly as had been expected in February. Further out, the Bank of England also said inflation would “fall back materially,” a comment that, combined with the gloomy outlook for living standards, suggests a degree of pushback against market pricing for rates to hit 2 per cent by the end of the year. – Bloomberg