The Bank of England (BoE) has raised its key interest rate by 0.25% to 4.5%, in a bid to tackle inflation that remains at over 10%. Governor Andrew Bailey pledged to “stay the course” and confirmed that the central bank had no plans to signal its next moves. Although the BoE no longer predicts a recession, it does expect inflation to fall at a slower pace than previously hoped, primarily due to persistent and significant increases in food prices, as well as stronger wage growth. Most economists had expected a rise and have been betting on further increases; in the wake of the latest rise, investors were pricing in a peak of almost 5% for this autumn. The pound rose and then fell again, whilst government bond yields rose, but settled back to their levels before the announcement.
The BoE was the first central bank to raise borrowing costs in December 2021, but has been criticised for not moving aggressively enough, and this latest rise follows criticism for a lack of response to the highest inflation for four decades in October last year. Despite the recent increases, the central bank expects inflation to remain at over 5% until the end of the year, only dropping to its 2% target by early 2025.
The central bank is worried that strong headline pay growth could become a long-term problem for the economy and is forecasting much stronger wage growth and lower unemployment than three months ago. However, the Bank is concerned that businesses and individuals will have to accept that their earnings have fallen in inflation-adjusted terms. It also predicted the UK economy will grow by 0.25% this year, compared to its earlier forecast of a 0.5% contraction. Energy prices have fallen sharply, although food prices have risen more than anticipated, adding around 1 percentage point to future inflation, according to the BoE.
Upcoming inflation data releases, starting on May 24 with figures for April, could be “a source of market volatility”, according to economists, with sterling now pricing in more aggressive action from the BoE compared to other central banks. Although rates are expected to have peaked, some analysts suggest they could remain at their current level until 2024 before being cut.
