Bank of England raises interest rates to 2.25%, despite likely recession

LONDON, Sept 22 (Reuters) – The Bank of England raised its key interest rate to 2.25% from 1.75% on Thursday and said it would continue to “respond strongly, as appropriate” to inflation, despite the economy entering recession.

The BoE estimates that the UK economy will shrink by 0.1% in the third quarter – partly due to the extra bank holiday for Queen Elizabeth’s funeral – which, combined with a fall in output in the second quarter, meets the definition of a technical recession.

Economists polled by Reuters last week had predicted a repeat of August’s half-point rise in interest rates, but financial markets had been betting on a three-quarter rise, the biggest since 1989, barring a brief, failed attempt in 1992 to prop up sterling.

The BoE move follows the US central bank’s decision on Wednesday to raise key interest rates by three-quarters of a percentage point, as central banks around the world grapple with post-Covid labor shortages and the impact of Russia’s invasion of Ukraine on energy prices.

“Should the outlook suggest more sustained inflationary pressures, including from stronger demand, the committee will respond strongly, as appropriate,” the BoE said, using similar wording to previous months for its policy intentions.

The BoE’s Monetary Policy Committee voted 5-4 to raise interest rates to 2.25%, with Deputy Governor Dave Ramsden and external MPC members Jonathan Haskel and Catherine Mann voting for a rise to 2.5%, while new MPC member Swati Dhingra wanted a smaller increase to 2%.

The MPC also voted unanimously to reduce the BoE’s £838bn of government bonds by £80bn over the coming year, by letting bonds mature and through active selling, starting next month. This is in line with the objective it stated in August.

The BoE now expects inflation to peak at just under 11% in October, down from the 13.3% peak it forecast last month, before Liz Truss won the Conservative Party leadership and became UK prime minister on a promise to cap energy tariffs and cut taxes.

Inflation will remain above 10% for a few months after October, before falling, the BoE said.

Consumer price inflation fell to 9.9% in July from a 40-year high of 10.1% in August, the first drop in almost a year.

On Friday, new finance minister Kwasi Kwarteng will provide more details on the government’s fiscal plans, which could amount to more than £150 billion in stimulus.

The BoE said it would consider the implications of this for monetary policy at its November meeting.

However, it noted that the energy price cap, while reducing inflation in the short term, will increase pressure further out.

Before the rate decision, financial markets expected the BoE to raise rates to 3.75% by the end of the year, with a peak of 5% reached in mid-2023. Less than a year ago, BoE rates were at a record low of 0.1%.

Sterling fell to its lowest since 1985 against the US dollar after Wednesday’s Fed decision, although it has held up against the euro.

(This story corrects planned gilt reduction in paragraph 7 to £80bn from £100bn)

Reporting by David Milliken; editing by Farouq Suleiman

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