The Bank of England raised interest rates by three-quarters of a percentage point on Thursday, the biggest hike in 33 years, as it tries to contain rising inflation even as the UK economy slides into a recession that could last for two years.
The central bank made its eighth interest rate hike in less than a year, taking its benchmark rate to 3%, the highest it has been since November 2008.
The big rise coincides with moves made by the US Federal Reserve on Wednesday and the European Central Bank last week.
“Inflation is too high and it’s the bank’s job to bring it down,” Governor Andrew Bailey said at a news conference after the announcement. “If we don’t act forcefully now, it will be worse later.”
As the Bank of England raises borrowing costs to limit rising prices, the British economy is expected to suffer.
The central bank believes economic output is already contracting, and its latest projection is for the recession to continue into the first half of 2024 “as high energy prices and materially tighter financial conditions weigh on expenditure”.
Compared to previous UK recessions, gross domestic product is expected to remain weak compared to pre-recession levels for a “long” period, Mr Bailey said.
A two-year recession would be longer than the one that followed the 2008 global financial crisis, although the Bank of England said any fall in GDP in the run-up to 2024 was likely to be relatively small.
The British pound fell sharply after the announcement, falling 2% against the US dollar to $1.117. It also fell by 1.2% against the euro.
Since the Bank of England’s last meeting, UK financial markets have gone through a period of unprecedented turbulence and the outlook for the economy has deteriorated.
Former prime minister Liz Truss’ “mini” budget at the end of September, with its promise of 45 billion pounds ($51.6 billion) of unfunded tax cuts, crashed the pound, collapsed the bond prices, sent the mortgage markets into chaos and prompted an emergency intervention by the Bank of England to rescue strained pension funds.
While Truss’ tax cut plans have largely been abandoned, bringing calm back to markets and easing medium-term inflation expectations, rising food and energy costs are keeping prices under pressure tall The annual inflation rate rose to 10.1% in September, from 9.9% in August, and returned to a 40-year high in July.
Bailey acknowledged the “tough road ahead.”
The central bank does not think inflation will start to fall until next year. That will require more interest rate hikes in the coming months, although Bailey said market expectations appeared too aggressive.
Those remarks contrasted with Fed Chairman Jerome Powell, who said they may have to hike more than previously expected.
Responsible for central bank policy they now await the government’s budget announcement on November 17 for more details on spending plans and fiscal policies, which could influence what happens to inflation next year.
Despite recent turmoil in the bond market, the Bank of England this week pushed ahead with plans to reduce its balance sheet, selling 750 million pounds ($859 million) of short-term government debt on Tuesday. In a sign of renewed confidence in Britain, investors bid for bonds worth about 2.45 billion pounds ($2.8 billion), Reuters reported.