British central bank adopts historic interest rate hike despite ‘quite challenging’ scenario

The British central bank raised interest rates to 3% on Thursday (3), from 2.25%, the biggest increase since 1989 amid warnings of a “very challenging” scenario for the economy.

The Bank of England predicts that inflation will hit a 40-year high of around 11% during the current quarter, but that the UK has already entered a recession that could last two years – longer than during the 2008 financial crisis – 09.

Thursday’s decision – the biggest in 33 years with the exception of a failed attempt to prop up the pound in 1992 – was in line with economists’ expectations in a Reuters poll, but not unanimous.

Two members of the Monetary Policy Committee, Silvana Tenreyro and Swati Dhingra, voted for smaller increases of a 0.25 and 0.5 percentage point respectively, as the economy was likely already in recession.

But most said rates would have to rise further, though probably not as much as the 5.2% that was priced in on financial markets when the Bank of England finalized its forecasts.

“Further rate hikes may be needed for a sustainable return of inflation to target, albeit at a lower peak than priced in financial markets,” the Bank of England said in exceptionally specific guidance.

Just before Thursday’s decision, markets had expected interest rates to peak at around 4.75%.

“The Committee continues to judge that if the outlook suggests more persistent inflationary pressures, it will respond forcefully as needed,” he added.

Central banks across the western world are responding to similar challenges. Inflation has skyrocketed in the last year due to residual labor shortages and supply chain bottlenecks since the Covid pandemic and – in Europe’s case – a huge increase in energy bills since Russia invaded Ukraine in February.

The Bank of England estimates that the British economy entered a recession in the third quarter of 2022 and that it will last until mid-2024, causing the economy to shrink by 2.9%.