Bank of England raises key interest rate to 4.5% and forecasts higher inflation

The Bank of England has raised interest rates by a quarter of a percentage point to 4.5 per cent, as it warned it would not hit its inflation target until 2025.

A seven to two majority on the central bank’s Monetary Policy Committee said the rise was needed to bring inflation back under control as they took rates to the highest level since 2008.

The BoE revised its short term inflation forecasts significantly higher as it admitted it had previously underestimated the strength and persistence of food price rises.

Instead of inflation falling below its 2 per cent target within a year, as it previously forecast, the BoE now thinks it will hit the target only at the start of 2025, after the latest date of the next general election.

It now expects inflation to fall from the current 10.1 per cent rate to 5.1 per cent in the fourth quarter of the year, instead of its previous forecast of 3.9 per cent. Any further deterioration in the inflation outlook would leave UK prime minister Rishi Sunak missing his pledge to halve inflation by the end of the year.

However, the bank now thinks the UK economy will avoid a recession relatively comfortably, forecasting that by mid-2026 gross domestic product will be 2.25 per cent larger than it expected in February.

The BoE thinks food price inflation will no longer be driving overall price rises in a year’s time. But it now expects that the general improvement in the economic outlook will mean that inflation will be above target subsequently.

Financial markets expect more rises in the cost of borrowing to come, with rates peaking close to 5 per cent.

The BoE forecasts did not push against such expectations and the MPC warned that “if there were to be evidence of more persistent [inflationary] pressure, then further tightening in monetary policy would be required”.

It said growth prospects had increased not just because of lower energy prices but also more robust consumer and corporate confidence and the March Budget’s public spending increases.

BoE officials stressed that the growth forecast was still weak with annual growth rates struggling to exceed 1 per cent over the next three years while unemployment would edge higher from 3.8 per cent at present to 4.5 per cent by 2026.

The main effects of the rises in interest rates from 0.1 per cent in December 2021 to 4.5 per cent have not yet been felt by households, the BoE said in its monetary policy report, with only a third of the full impact in place.

The MPC members voting to hold rates at 4.25 per cent, Swati Dhingra and Silvana Tenreyro, said that the delayed effect of previous rises were still to come. They maintained this was likely to push inflation down too far, raising the need for interest rates to be cut in future.

Sterling strengthened 0.2 per cent against the dollar, to trade at $1.26, after falling 0.5 per cent ahead of Thursday’s announcement. The pound has risen more than 20 per cent since September.

Additional reporting by Daria Mosolova