The Bank of England raised interest rates for a 10th consecutive time on Thursday, by half a percentage point, as policymakers kept up their vigilant stance against inflationary pressures.
The bank’s policymakers lifted the key rate to 4 percent, the highest since 2008. But after more than a year of rising interest rates, inflation in Britain and several other major economies appears to have peaked, and the bank’s officials softened their tone on the future path ofrate increasesas the economy enters a contraction.
In recent policy meetings, officials have said they would act “forcefully” against signs of persistent inflationary pressures. Crucially, the mention of “forceful” was no longer in the minutes of the bank’s meeting this week.
Instead, the bank said “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required,” according to the minutes of the meeting published on Thursday.
“We have seen a turning of the corner” on inflation, Andrew Bailey, the governor of the bank, said at a news conference. “But it’s very early days and the risks are very large.”
The bank stressed the battle against inflation wasn’t won. Even though the overall rate of inflation may have peaked at a 41-year high late last year, it remains stubbornly elevated, at an annual rate of 10.5 percent in December.
Recent data also showed inflation in the services sector and wage growth still rising faster than expected, increasing concerns that underlying inflation will be persistently high. Meanwhile, food inflation was still rising, hitting a 45-year high of 16.8 percent in December. The bank forecasts overall inflation to fall to 4 percent by the end of the year, double the central bank’s target, and said the risks are that it overshoots by even more.
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If those risks materialize and inflation overshoots expectations, especially in wages and the services sector, then “we have to respond to that,” Mr. Bailey said. But if the economy evolves as expected, policymakers would “re-evaluate,” he added.
Analysts at ING, a Dutch bank, said it was “abundantly clear” the Bank of England was “laying the groundwork for the end of the current tightening cycle.”
The European Central Bank, too, is expected to raise rates on Thursday as it continues to battle inflation. This week, data showed that the annual rate of inflation for the 20 countries that use the euro fell to 8.5 percent in January, from 9.2 percent the previous month but core inflation, which excludes volatile energy and food prices, held firm.
And on Wednesday, the U.S. Federal Reserve raised rates a quarter point, to a range of 4.5 to 4.75 percent. It was the Fed’s eighth increase in a year but the smallest since March, as officials said that inflation had finally started to meaningfully ease.
On Thursday, the Bank of England also updated its forecasts for the economy, presenting a much less dismal outlook than it had three months ago.
In 2023, the bank expects the economy to shrink by half a percentage point, instead of the 1.5 percent contraction it forecast in November. While the contraction is expected to last five quarters from now, it’s a much milder recession than previously expected because of lower wholesale natural gas prices, the expectation that the central bank won’t have to raise interest rates as high as previously anticipated, and unemployment rising less than previously forecast giving consumers more confidence to spend. The bank’s forecasts were based on the assumption that its rate would peak at 4.5 percent in the middle of the year, based on financial markets.
But the outlook still can’t be described as good. The British economy isn’t expected to reach it’s prepandemic size before 2025, which is as far as the bank’s forecasts go.
Earlier this week, the International Monetary Fund downgraded its forecast for the British economy, predicting a 0.6 percent contraction in 2023, instead of the 0.3 percent expansion it forecast last October. While the size of the decline isn’t far from the Bank of England’s new forecast, the fund’s prediction stands out because it presented Britain as an outlier. The I.M.F. upgraded its outlook for global growth.
Among the challenges facing the British economy is the size of its work force, which hasn’t returned to its prepandemic level. Since February 2020 half a million more people have counted as economically inactive, as workers over 50 retire early and more people report having long-term sickness. A tighter labor market is restraining potential growth and putting upward pressure on private-sector wages.
Though the wage growth isn’t fast enough to keep up with inflation, policymakers are concerned that higher pay could embed inflationary pressures deeper into the economy. In the three months to November, annual private-sector wage growth was about 7 percent, and the bank said that rate to continue at similar levels through the first half of the year. That could make it hard to sustainably return inflation to the central bank’s 2 percent target and could keep interest rates higher for longer.
The impact of higher interest rates is expected to be felt more acutely this year. About 1.7 million home mortgages are expected to be renewed over the course of the year, with the average mortgage holder paying just under 3,000 pounds (about $3,700) more a year in interest payments, the bank estimated.
And despite falling wholesale energy prices, Britons are still experiencing high energy bills. In April, the average household will face a £500 increase in the annual energy costs, to £3,000.
Overall, incomes after tax, adjusted for inflation, are expected to fall by 1.5 percent this year. But that’s about half the decline that was projected three months ago.
As at December’s meeting, two members of the Bank of England’s nine-person rate-setting committee voted to hold interest rates steady rather than increase them. They argued that higher interest rates were already tightening financial conditions, and that the weakness in the economy from incomes lagging far behind inflation was a reason to stop. The two members, Swati Dhingra and Silvana Tenreyro, said that the effects of higher interest rates were still to be seen in the economy, and so monetary policy was already set to reduce inflation below the bank’s target in the medium term.