UK interest rates raised by 0.5% to 4%

Bank of England increases cost of borrowing as most analysts expected

The Bank of England has announced the latest rise in the cost of borrowing. AFP

The Bank of England has raised interest rates by 0.5 per cent to 4 per cent in its continuing battle to reduce the UK's stubbornly high rate of inflation.

Inflation fell back slightly in December to 10.5 per cent, having hit a 41-year high of 11.1 per cent in October.

UK interest rates are now at their highest levels since late 2008 and a BoE statement warned that further tightening of rates was possible.

After more than a decade of record-low interest rates, the central bank began raising borrowing costs in December 2021, when its key rate stood at only 0.1 per cent. “The extent to which domestic inflationary pressures ease will depend on the evolution of the economy, including the impact of the significant increases in bank rate so far,” the bank said in the Thursday statement. “There are considerable uncertainties around the outlook.”

The bank stepped up its fight against inflation last year, approving four big increases of 0.5 per cent or more since August to bring the rate to 3.5 per cent in December.

"We have done a lot on rates already. The full effect of that is still to come through. But it's too soon to declare victory just yet, inflationary pressures are still there," said BoE governor Andrew Bailey.

The European Central Bank (ECB) also increased interest rates by 0.5 per cent on Thursday, taking the main refinancing operations rate to 3 per cent, the interest rate on the marginal lending facility to 3.25 per cent and the deposit facility to 2.5 per cent.

The move was in line with what the ECB, which covers the 20 countries that use the euro as currency, had said in December.

"In view of the underlying inflation pressures, the governing council intends to raise interest rates by another 50 basis points at its next monetary policy meeting in March and it will then evaluate the subsequent path of its monetary policy," the ECB said on Thursday.

Meanwhile, the BoE's nine-person Monetary Policy Committee (MPC) that sets UK rates was split 7-2 in favour of increasing them.

Silvana Tenreyro and Swati Dhingra voted to leave rates unchanged at 3.5 per cent, saying the effect of past increases has yet to take full effect.

Catherine Mann, who voted for a 0.75 per cent increase in December, joined the majority of MPC members in calling for 0.5 per cent rise.

UK Chancellor Jeremy Hunt said the latest rise in rates was necessary and that "inflation is a stealth tax that is the biggest threat to living standards in a generation, so we support the Bank's action today so we succeed in halving inflation this year."

“While inflation is coming down thanks to lower energy prices, labour market shortages and broader inflationary pressures mean higher rates are still needed to bring inflation back to the 2pc target," said Anna Leach, deputy chief economist at the Confederation of British Industry (CBI).

“Rising interest rates, high inflation and tightening fiscal policy will challenge economic growth this year. The government needs to act decisively in the forthcoming Budget to reinforce the UK’s position as a global centre for innovation and the low carbon economy,” she added.

Kitty Ussher, chief economist of the Institute of Directors, said: “Inflationary pressures are more persistent than the Bank of England had previously anticipated. Core inflation is not yet falling, and price rises are still accelerating for some sub-categories, including food."

Market reaction

The 0.5 per cent rise in interest rates was broadly expected by the financial markets.

The British pound fell slightly against the dollar and euro after the rate announcement and the accompanying release of the minutes of the MPC meeting.

The MPC softened its language in the minutes, removing a promise to act "forcefully" to return inflation to its target.

"Looking further ahead, the MPC would adjust the bank rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit," the minutes said.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said: "In these minutes, a brighter outlook has emerged, with unemployment not rising so high, and the economic contraction set to be milder.

"It’s a ray of light in an otherwise gloomy week with Britain’s laggard status among the G7 being confirmed by the IMF. But pessimism does look set to seep away."

The pound fell 0.45 per cent against the euro at €1.12 shortly after the decision was announced, and 0.36 per cent against the dollar at $1.23.

In fixed income markets, the yield on the 10-year gilt dipped 0.13 percentage points to 3.17 per cent, as the price of the debt rose. London’s FTSE 100 share index was 0.5 per cent higher shortly after the rate announcement.

Mortgage payments

The interest rate rise will increase borrowing costs for about 2.2 million people who are on variable-rate mortgages. More than a million households could join them this year, as their fixed-rate deals come to an end.

Shadow chancellor Rachel Reeves said the latest rise in interest rates will add to the woes of homeowners.

"With households already paying a Tory mortgage penalty, families across the country will be worried about what rising interest rates today mean for them," she said.

The rate rise comes as Santander bank warned that house prices were set to tumble by as much as 10 per cent this year.

The Spanish-owned lender said it has set aside more cash for bad debts this year, as it braces for a possible rise in borrowers falling behind with repayments.

Federation of Small Businesses (FSB) national chairman Martin McTague said: "Consumer spending is stuck in the doldrums with retail spending over the festive period anaemic at best.

"Increased mortgage and loan costs will further dampen people's willingness and ability to open their purses, spelling further pain in the short term for consumer-facing industries, which will inevitably feed through to other sectors as the situation persists."

The International Monetary Fund (IMF) this week said the UK was likely to be the only major economy to shrink this year, even as the outlook for the rest of the world improves.

It said the country’s GDP was likely to contract by 0.6 per cent this year, compared with its previous forecast of 0.3 per cent growth.

The general secretary of the Trades Union Congress Paul Nowak said the BoE was taking a gamble with its latest rise in the cost of borrowing.

He said: "The IMF's recession forecast for the UK should have been cause for caution, but the Bank has taken a very big risk by pushing rates up, and if we spend this year in recession, working people will pay a high price."