The Bank of England (BoE) raised interest rates for the 11th consecutive time on Thursday following a surprise rise in inflation which dashed hopes prices would continue to drop.
Policymakers on the BoE's Monetary Policy Committee (MPC) voted seven-to-two to increase rates from 4 per cent to 4.25 per cent.
But committee members say they now expect the economy to grow slightly in the second quarter, marking a reversal of the 0.4 per cent decline in gross domestic product (GDP) that the BoE had anticipated last month.
The pound rose and investors priced in more certainty of at least one more rate raise this year. The UK currency rose 0.3 per cent to $1.2309 compared to $1.2305 before the decision.
The interest-rate increase came amid the central bank's continued battle to rein in inflation.
Economists had believed prices were on course to fall steadily, after hitting a 41-year high of more than 11 per cent in October.
But data released on Wednesday showed inflation actually rose to 10.4 per cent in February from 10.1 per cent the previous month, rather than continuing its descent. The increase was driven by the cost of food, clothing and dining out.
It ended a three-month run of falls and immediately turned Thursday's announcement into an almost one-way bet on a quarter-percentage-point increase in the bank rate.
"CPI [inflation] increased unexpectedly in the latest release, but it remains likely to fall sharply over the rest of the year," the BoE said.
It added it would “continue to monitor closely indications of persistent inflationary pressures".
“If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required," it said.
As recently as Tuesday, investors were split almost 50-50 on whether the BoE would leave the bank rate unchanged for the first time since November 2021 after the rescue of Credit Suisse and the collapse of Silicon Valley Bank.
Investors in rate futures markets are now positioning for possibly two more 25-basis-point moves by the BoE by September after Thursday's increase.
Some of the rise in the headline rate of British inflation announced on Wednesday was due to potentially one-off factors such as cold weather in Spain and North Africa that caused vegetable shortages.
But the underlying inflation measures that the BoE watches also rose.
The BoE was the first major central bank to start raising rates in December 2021 and had seemed likely to join the Bank of Canada, which this month stopped raising borrowing costs.
BoE governor Andrew Bailey and his colleagues last month dropped language saying that they were ready to act forcefully if the outlook suggested persistent inflationary pressures.
Thursday’s move was the smallest rate rise since May as the BoE forecasts a steep drop in inflation later in the year.
Inflation has proved to be more stubborn in Britain than elsewhere, partly because it has been more exposed to the jump in natural gas prices triggered by Russia’s invasion of Ukraine.
It is even more affected than mainland Europe, which got through the winter heating season largely without Russian supplies of natural gas and has a lower inflation rate of 8.5 per cent in the 20-country euro area.
Inflation in the UK is expected to slow to 2.9 per cent by the end of the year as energy costs fall and big price increases recorded last year drop out of the calculation.
Central bankers worldwide are struggling to balance competing economic demands as they try to rein in inflation, which erodes savings and increases costs for consumers and businesses, without unnecessarily damaging economies weakened by the Covid-19 pandemic, Russia’s war in Ukraine and now banking upheaval.
The US Federal Reserve weighed in with its assessment of the risks on Wednesday, raising its key interest rate by a quarter-point as chairman Jerome Powell tried to reassure Americans it was safe to leave money in their bank accounts.
The European Central Bank last week stuck to its plans and raised rates by 50 basis points despite the Credit Suisse turmoil, a move repeated by the Swiss National Bank on Thursday as it warned that more increases could not be ruled out.
Switzerland and Norway also raised interest rates on Thursday to tackle inflation, despite the continuing banking-sector turmoil.