The Bank of England raised interest rates to pre-pandemic levels on Thursday in a bid to curb rapidly rising inflation exacerbated by the war in Ukraine.
The central bank raised interest rates by 0.25 percentage point to 0.75 percent, the third consecutive hike at a policy meeting, as it forecast inflation would be around 8 percent in the coming months and possibly pick up later in the year. But the decision was not unanimous as policymakers weighed in on the bleak outlook for the UK economy.
While the war has led to higher energy and commodity prices, pushing up the expected spike in inflation, economic growth in Europe, including Britain, is also forecast to slow. This creates a challenge for the bank. The aim is to bring inflation, which stood at 5.5 percent in January, to the target of 2 percent, but policymakers want to avoid the economy cooling too aggressively and taking the nascent recovery after the lockdown off course.
“The outlook for the global economy deteriorated significantly after the Russian invasion of Ukraine in late February and the accompanying material rise in energy and commodity prices,” the bank said in a statement.
For now, global central bankers are focused on taming inflation. On Wednesday, the Federal Reserve raised U.S. interest rates for the first time since 2018, forecasting six more hikes this year as inflation rises. Last week, the European Central Bank got closer to raising its interest rates when it proposed an end date for its bond-buying program. On Thursday, European Central Bank president Christine Lagarde said it is unlikely that Europe will return to prepandemic inflationary patterns, which have consistently fallen short of the bank’s target.
For Britain and Europe as a whole, the economic fallout from war comes on the heels of a shock in energy prices that began last fall and just months after the economy regained its prepandemic size.
“The economy has recently been subject to a succession of very large shocks,” the Bank of England said on Thursday. “The Russian invasion of Ukraine is another shock.” If energy and commodity prices remain high, they will weigh on the UK economy.
“This is something monetary policy cannot prevent,” the bank added.
The bank’s series of rate hikes began in December, the first step higher in three and a half years. The rate was 0.1 percent since March 2020, when the onset of the pandemic rocked financial markets and the government introduced lockdown measures for the first time.
On Thursday, the bank said it had raised interest rates to prevent higher wage and consumer prices from getting stronger and firmer.
The bank previously expected inflation to peak in April, when the government price cap on energy bills rises. But it now says inflation could be even higher later this year — possibly several percentage points higher because of energy prices.
Even as inflation moves further from the bank’s target, it’s unclear how many rate hikes are yet to come. The central bank reiterated that “further modest tightening” in monetary policy may be appropriate, but added a warning on Thursday, saying there are risks associated with this judgment, depending on the path of inflation.
The pound fell about 0.8 percent from its overnight high against the US dollar following the policy announcement, as traders saw growing hesitation in policymakers’ minutes about tightening monetary policy. There was no longer a suggestion of raising rates by 0.50 percentage points, which some policymakers had voted for in February, and there were growing concerns about the tight household income.
The Bank of England “is much more cautious than the Fed,” strategists at Dutch bank ING wrote in a note to customers. “That reminds us that the UK, like Europe, is an energy importer and more prone to events in Ukraine.”
ING strategists expect another rate hike in May, but said the bank could pause after that.
Before the war there were already concerns in Britain about a crisis in the cost of living. Inflation has outpaced wage growth, utility bills are set to skyrocket and tax hikes are slated for next month. The government is under mounting pressure to reconsider its plans to raise taxes when it announces a budget update next week.
The Russian invasion of Ukraine is “likely to accentuate both the spike in inflation and the negative impact” on economic growth by “intensifying pressure on household incomes,” the central bank said Thursday.
In February, the bank forecast that its measure of household net income after taxes and inflation would shrink 2 percent this year from last year. The impact on incomes is “probably materially greater now” due to higher commodity prices, the bank said Thursday.
Eight of the nine members voted in favor of the rate increase. Jon Cunliffe, a deputy governor for financial stability, voted to keep interest rates at 0.5 percent because of the “very material negative effects” on households from higher commodity prices. A broader assessment of this balance between higher inflationary pressures and the deteriorating outlook for household budgets is needed, according to the minutes of this week’s policy meeting.
