Bank of England raises interest rate to 0.5%

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London: The Bank of England has raised its key interest rate as part of a package of measures to contain inflation which is expected to reach 7%, as policymakers come close to offering an unprecedented increase in 50 basis points.

The increase from 0.25% to 0.5% was backed by five of the bank’s nine policymakers. In a surprise decision, four voted for a bigger hike, to 0.75%, a rise not seen since the bank’s independence in 1997. All said further modest tightening would be needed. In the coming months.

Officials also signaled the start of a new era for the £895billion of bonds piled up over the past decade under quantitative easing, and voted unanimously to begin the reduction process. of the balance sheet.

The BOE will immediately stop reinvesting the proceeds of expired gilts, allowing over £200bn to flow by 2025, and has announced its intention to dispose of the entire £20bn stock of corporate bonds by the end of 2023.

“Further modest tightening will likely be appropriate in the coming months” if the economy evolves as the BOE predicts, the rate-setting committee added.

Underlining its inflation-fighting mandate, the BOE said “the mandate is clear that the inflation target applies at all times, reflecting the primacy of price stability in UK monetary policy. “.

Rise in inflation forecasts

BOE officials raised their forecast for peak inflation to 7.25% in April, more than triple the BOE’s 2% target. Inflation was previously expected to peak at around 6%.

They also said the labor market remains very tight. They sharply raised their forecast for wage growth, predicting that the underlying pace will hit 4.75% in the coming year. Rising energy prices have added further pressure, while cost of living pressures will slow GDP growth.

Against this backdrop, four officials – Dave Ramsden, Michael Saunders, Catherine Mann and Jonathan Haskel – voted to raise rates by 50 basis points, seeing the need for faster action to lower inflation expectations. The majority, including Governor Andrew Bailey, opted for the 25 basis point hike.

This increase marks the first consecutive increase since 2004.

The UK’s central bank is leading the way for a global tightening of monetary policy as institutions scramble to cope with a rapid acceleration in prices following the pandemic shutdowns. The US Federal Reserve is expected to trigger its own rapid tightening cycle this year, and there has been speculation that could include a 50 basis point hike.

High cost of living

The decision also comes as the UK is in the grip of a cost of living crisis, which will intensify from April when rising taxes and energy prices hit consumers.

Despite the improving wage outlook, the BOE warned that real household incomes, after adjusting for inflation and tax hikes, will decline this year and next.

An hour before the BOE’s announcement, UK energy regulator Ofgem said a typical household’s energy bill would rise by 54% in April.

While the BOE admitted that the bull run itself could do little to address these immediate price increases, it stressed the need to anchor longer-term stability. The government is preparing a multi-billion pound package of measures to mitigate the impact of rising energy bills. The measures could also lower the overall inflation rate.

“The sharp rise in prices for global energy and tradable goods of which the UK is a net importer will weigh on aggregate real income and spending. This is something monetary policy is unable to prevent,” the BOE said.

The income squeeze will push unemployment up to 5% from around 4% currently, and cause the economy to slow further by the end of the forecast period. The economy is expected to return to pre-pandemic levels this quarter, with growth recovering from the omicron restrictions in February and March.

After that, growth is expected to slow to “moderate rates”, with the outlook slightly weaker than in November due to the impact of the cost of living crisis.

The BOE currently expects inflation to be slightly above target in two years and fall below target in three years. The projection is based on interest rates reaching 1.5% by the middle of next year, which suggests the BOE may not go that far.

An alternative scenario, based on energy prices following their forward curve, rather than remaining constant after six months, would lead to inflation falling to about 0.75 points below the target in two and three years. .

Markets have been anticipating steeper increases since the close of the forecast window and are close to a level of 1.5% by the end of the year. It would involve the biggest tightening of the policy for a calendar year since 1997.

The BOE also said it would immediately halt the process of reinvesting the proceeds of expired bonds held under its quantitative easing program, the first step in reducing its £895 billion in holdings.

This will begin in March, when 28 billion pounds of gilts will mature. The bank reiterated that it will begin to consider accelerating the process by continuing active selling once rates reach at least 1%.

The bank also said it would end reinvestments from its £20bn corporate bond plan and design an outright sell-off programme. This will see all of the stock unwind towards the end of 2023 at the earliest.

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