The Bank of England has increased interest rates by half a percentage point to a 15-year high of 4 per cent, but suggested that rates may have peaked.
The BoE, which is now anticipating a milder recession this year than previously thought, said further rises would only be needed if there were new signs that inflation was going to stay too high for too long.
Samuel Tombs, chief UK economist at Pantheon macroeconomics, said the BoE’s current expectations of declining inflation signal that it “doesn’t intend to hike rates any further.”
The bank dropped its previous guidance that it would need to act “forcefully”, although governor Andrew Bailey cautioned that the BoE still needed to be sure that inflation had been beaten.
The Monetary Policy Committee voted seven to two in favour of the 10th consecutive rate increase, which came a day after a quarter-point rise by the US Federal Reserve and just before the European Central Bank carried out its own 0.5 point increase.
While the ECB said it would “stay the course” on rate rises, the wording of the BoE’s statement suggests interest rates might peak at the new rate of 4 per cent, below the 4.5 per cent expected by financial markets.
“If there were to be evidence of more persistent [inflationary] pressures, then further tightening in monetary policy would be required,” the MPC said.
Sterling weakened on Thursday, trading 0.45 per cent lower against the euro at €1.12 and 0.36 per cent down against the dollar at $1.23.
The yield on the 10-year gilt slipped 0.13 percentage points to 3.17 per cent as the price of the debt rose. London’s FTSE 100 was up 0.5 per cent just after noon.
There was no attempt by the BoE to suggest financial markets are misguided in expecting interest rate cuts later this year. But MPC members warned “that the risks to inflation are skewed significantly to the upside”.
The BoE’s new central inflation forecast shows it thinks price rises will ease quickly from December’s 10.5 per cent annual rate to a level under 4 per cent by the end of the year. Inflation is forecast to drop well below the BoE’s 2 per cent target in 2024.
Explaining why the BoE raised rates despite such predictions, Bailey said “we need to be absolutely sure we really are turning the corner on inflation”.
The two dissenting voices on the MPC — Swati Dhingra and Silvana Tenreyro, who voted to leave interest rates at 3.5 per cent — argued that Thursday’s rise to 4 per cent “would bring forward the point at which recent rate increases would need to be reversed”.
The BoE’s new forecasts were less pessimistic than previous predictions in November. It now thinks wholesale gas prices will be lower and assumes companies will be reluctant to lay off employees during a difficult time for the economy.
The central bank is now predicting a mild recession, but it made clear it thought UK economic performance would be weak for some time.
It expects gross domestic product to contract 0.7 per cent for the fourth quarter of the year compared with the last quarter in 2022. That is marginally more pessimistic than the IMF, which this week forecast that the UK economy would shrink 0.5 per cent in the same period.
After looking at the likely supply of workers, low business investment and trade weakness, BoE officials think the UK economy cannot expand even at a 1 per cent annual rate without generating inflationary pressures.
Before the financial crisis of 2007-8, the equivalent sustainable average annual growth rate was 2.5 per cent, while before the coronavirus pandemic it was around 1.5 per cent. The BoE attributed the long-term underlying weakness of the economy to Brexit, the pandemic and the energy crisis.
The BoE’s downgrade implies it expects the output to be no higher at the start of 2026 than it was just before the pandemic at the end of 2019.