The Bank of England unveiled its biggest rise in interest rates in more than three decades on Thursday, aiming to tame soaring levels of inflation as it predicted a peak inflation rate of just under 11 per cent.
The bank's Monetary Policy Committee (MPC) rose the base rate by 0.75 percentage points to 3 per cent.
That represents the eighth consecutive jump in interest rates by the central bank, and the biggest increase since 1989.
The MPC voted 7-2 in favour of lifting rates by 75 basis points, something that could be seen as dovish by the markets.
Sterling weakened on the foreign exchanges, to sit at $1.1201 — 1.7 per cent down — at 12.20pm local time after the rate rise was imposed, its lowest level since October 21.
The increase will pile about £3,000 ($3,442) per year on to mortgage bills for those households that are set to renew their mortgages, the bank said.
It also warned that the UK could be on course for the longest recession since reliable records began in the 1920s, as the economy faces a “very challenging outlook”.
Gross domestic product (GDP) could shrink for every quarter for the next two years, with growth only returning in the middle of 2024.
“Increasing interest rates when the economy is already in a recession is not a typical course of action for a central bank, but these are exceptional times and the BoE had to act to tame double-digit inflation, which is constraining expenditure for companies and consumers alike,” said Alice Haine, personal finance analyst at broker BestInvest.
The bank warned that more increases are likely. But in a statement it said the peak in expected rates would probably be “lower than priced into financial markets”.
Inflation currently sits at 10.1 per cent and the bank's forecasts see inflation peaking at 10.9 per cent in the coming months. With rising rates it sees this spike falling to zero by 2025, though it warned the risks were to the upside.
Ahead of the announcement sterling slid against the dollar early on Thursday as traders awaited the Bank's announcement and digested an overnight US rate rise.
The greenback rose along with US bond yields after Fed Chairman Jerome Powell signalled that interest rates were likely to have to rise higher than expected to crush inflation.
The dollar's rise was particularly pronounced against the pound, with traders selling sterling in expectation the Bank of England would strike a less aggressive tone than the Fed.
“We expect the Bank of England to signal that a larger hike today is unlikely to be the first of a series of larger hikes,” said Lee Hardman, currency analyst at MUFG, in a note to clients.
“It should encourage a weaker pound.”
The UK's new Prime Minister Rishi Sunak has pushed the government's fiscal statement back to November 17, adding to uncertainty in the markets after the bank's move.
The government is expected to announce tax rises and spending cuts as part of the budget, potentially further weighing on growth.
Michael Quinn, senior trader at Monex Europe, said the drop in sterling was driven by bets that the BoE will struggle to raise rates as high as the Fed.
Higher rates — or the expectation of them — traditionally boost a country's currency by making investments there look more attractive.
“The story is definitely moving from central banks pivoting to central bank policy divergence. The fundamentals in the US are certainly more robust and healthy than in Europe,” he said.
“It's a pretty grim scenario for sterling at the moment.”