Pound slumps as Bank of England raises interest rates to 1%

Central bank forecasts 10 per cent inflation and recession

People walk past the Bank of England in central London on Thursday. AP Photo / Frank Augstein
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Britain's pound slumped against major currencies after the Bank of England raised interest rates from 0.75 per cent to 1 per cent — a 13-year high — as inflation in the UK sits at the highest level in 30 years.

The BoE announced a fourth consecutive rise of 25 basis points on Thursday, the first such run since 1997. The jump was in keeping with a global trend that has forced central banks to tackle soaring inflation.

The Monetary Policy Committee (MPC) voted 6-3 for the increase, even as the bank said Britain risks falling into recession. But economists Catherine Mann, Jonathan Haskel and Michael Saunders called for a bigger increase to 1.25 per cent to stamp out the risk of the inflation surge getting embedded in the economy.

The pound fell by more than a cent against the US dollar to its lowest level since mid-2020, below $1.24, as investors reacted to the darker economic forecasts.

“Sterling has moved lower on the back of the BoE interest rate decision as traders are disappointed that not many BoE officials are supporting more than a 25-basis-point interest rate hike”, said Naeem Aslam, chief market analyst at AvaTrade.

“Traders are still looking for an interest rate hike for every single meeting for the rest of the year but something even more important is shrinking the balance sheet. For now, traders are showing more disappointment here.”

Households across Britain are under increasing strain due to the rising cost of living, with inflation rocketing to 7 per cent — the highest level recorded since 1992. Record petrol prices and rising gas and electricity costs made worse by Russia’s invasion of Ukraine have fuelled the rise.

“Any decision to increase rates has to be approached very carefully, with Bank Governor Andrew Bailey needing to address not just the toxic mix of slowing growth and high inflation — known as stagflation — but also the struggles faced by consumers during the cost of living crisis”, said Alice Haine, an analyst at investing platform Bestinvest.

“With the headline inflation rate already running at a three-decade high, it was little surprise that the BoE expects inflation to hit just over 9 per cent in the second quarter of this year and over 10 per cent at its peak towards the end of the year.”

Sterling's drop came a day after the US Federal Reserve hiked interest rates by 0.5 per cent — its biggest rise in 22 years.

In its report, the Bank's Monetary Policy Committee (MPC) said the jump in energy prices will drive the continued growth in inflation.

“Consumer Price Index inflation is expected to rise further over the remainder of the year, to just over 9 per cent in 2022 Q2 and averaging slightly over 10 per cent at its peak in 2022 Q4,” the MPC said.

“The majority of that further increase reflects higher household energy prices following the large rise in the Ofgem price cap in April and a projected additional large increase in October.

“The price cap mechanism means that it takes some time for increases in wholesale gas and electricity prices, and their respective futures curves, to be reflected in retail energy prices,” the MPC said.

“Given the operation of the price cap, consumer price inflation is likely to peak later in the United Kingdom than in many other economies, and may therefore fall back later.

“The expected rise in CPI inflation also reflects higher food, core goods and services prices.”

In a note to investors, Dmitri Theodosiu, head of foreign exchange and interest rates trading at Investec, said the nine-member committee “has a difficult job ahead of it” as inflationary pressures from external factors are increasing.

“And with the cries of ‘higher, higher’ ringing in the ears comes the knowledge that too much intervention could see a damaging fall to the economy,” he said.

The Federal Reserve on Thursday played down the chances of an even more drastic rise in interest rates in the near future.

Oil prices steadied, a day after big gains as the European Union proposed a gradual ban on Russian crude following President Vladimir Putin’s invasion of Ukraine.

Updated: May 05, 2022, 3:12 PM