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 level 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 of rate increases as 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 that “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 that the battle against inflation hadn’t been 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 inflation will be persistently high. Food inflation was rising, too, hitting a 45-year high of 16.8 percent in December. The bank forecasts that overall inflation will fall to 4 percent by the end of the year, which is still double its target. By the second quarter of 2024, inflation is expected to fall below the 2 percent target, but the bank cautioned that there were significant risks that it might not fall that far.
If those risks materialize and inflation exceeds expectations, especially in wages and the services sector, then “we have to respond to that,” Mr. Bailey said.
Analysts at ING, a Dutch bank, said it was “abundantly clear” that the Bank of England was “laying the groundwork for the end of the current tightening cycle.”
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 inflation had finally started to meaningfully ease.
The European Central Bank also raised rates on Thursday by half a point and said another half-point increase was likely in March as inflation was still too high, even though the overall rate appeared to have peaked. In the eurozone, core inflation, which excludes energy and food prices, is at a record high of 5.2 percent, and there are other signs of strong inflationary pressures.
“We know that we are not done,” said Christine Lagarde, the president of the bank.
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. The contraction is expected to last five quarters from the current quarter, but 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 that is rising less than previously forecast, giving consumers more confidence to spend. The bank’s forecasts were based on financial market expectations that its interest rate would peak at 4.5 percent in the middle of the year.
But the outlook still cannot be described as good. The British economy is not expected to reach its 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 in 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 has not 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 is not 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 was expected to continue at similar levels through the first half of the year. That could make it hard to sustainably return inflation to 2 percent 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 this 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 1.5 percent this year. But that is 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 the effects of higher interest rates were still to be seen in the economy, so monetary policy was already set to reduce inflation below the bank’s target in the medium term.
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