The Bank of England has voted to increase interest rates to 0.25 per cent from 0.1 per cent, sparking a jump in the pound as the market was caught by surprise.
At a meeting on Thursday, members of the bank’s monetary policy committee voted eight to one to raise rates a day after inflation soared to a 10-year high, making the BoE the first big central bank to raise borrowing costs since the Covid-19 pandemic battered the global economy last year.
Sterling jumped by three quarters of a cent against the US dollar to its highest since November 30, and interest-rate sensitive two-year gilt yields rose by more than seven basis points on the day to 0.56 per cent, their highest since December 1.
The European Central Bank said its rates would remain unchanged.
“The interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00 percent, 0.25 percent and -0.50 percent respectively,” the ECB said in a statement.
The decision confounded market expectations for no change as the country grapples with a sharp rise in Covid-19 infections. But it came one day after news that UK inflation rose sharply in November to 5.1 per cent, more than double the BoE's 2 per cent target.
“The committee continues to judge that there are two-sided risks around the inflation outlook in the medium term, but that some modest tightening of monetary policy over the forecast period is likely to be necessary to meet the 2 per cent inflation target sustainably,” the BoE said.
The BoE said inflation was on track to hit 6 per cent in April and suggested it no longer sees inflation as a transitory issue. "The labour market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures," a statement said. "Although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage."
In a poll conducted by Reuters, the majority of economists had expected the BoE to keep the rate at 0.1 per cent amid a new surge in coronavirus cases.
A record-breaking 78,610 infections were recorded in the UK on Wednesday.
Consumer confidence has been seriously damaged by the rapid spread of the Omicron variant in the run-up to the Christmas period.
The committee said the level of global GDP in the fourth quarter of 2021 is still expected to be similar to last month’s projection, but that consumer price inflation “has risen more than expected”.
It said Omicron could hinder economic activity at the start of next year.
Bank officials said they had revised down their expectations for the levels of UK GDP in the fourth quarter by around 0.5 per cent since the BoE's meeting, leaving GDP around 1.5 per cent below its pre-Covid level.
“Growth in many sectors has continued to be restrained by disruption in supply chains and shortages of labour,” it said.
“The impact of the Omicron variant, associated additional measures introduced by the UK government and devolved administrations, and voluntary social distancing will push down on GDP in December and in 2022 Q1.”
Suren Thiru, head of economics at the British Chambers of Commerce, called the Bank’s decision “surprising” given the “mounting uncertainty” caused by Omicron.
“While today’s rate increase may have little effect on most firms, many will view this as the first step in a longer policy movement – not as a partial reversal of last year’s cut,” he said.
“While policymakers are facing a tricky trade-off between surging inflation and a stalling recovery, with the current inflationary spike mostly driven by global factors, higher interest rates will do little to curb further increases in inflation.
“Instead, it is vital more than ever that the government’s supply chain advisory group and industry task force start to provide some practical solutions to the supply and labour shortages that are continuing to stoke inflationary pressures."
He said supply chains would likely continue to be hampered by rising prices, "even with fiscal policy responses”.
The BoE cut its growth forecasts for December and the first quarter of 2022 because of the spread of Omicron.
Meanwhile, the central bank will keep up its £895 billion ($1,185bn) quantitative easing programme after a unanimous vote in favour.