Bank of England raises rates to 3.5%, sees more hikes ahead

© Reuters. FILE PHOTO: A bird flies past The Bank of England in the City of London, Britain, December 12, 2017. REUTERS/Clodagh Kilcoyne/File Photo

By David Milliken and Farouq Suleiman

LONDON (Reuters) -The Bank of England raised its key interest rate to 3.5% from 3% on Thursday and indicated that more hikes were likely, despite a looming recession, as it tries to speed inflation's return to target after price growth hit a 41-year high in October.

The BoE's Monetary Policy Committee voted 6-3 in favour of the move, and said "further increases in Bank Rate" may be required to tackle what it fears could prove to be persistent domestic inflation pressures from prices and wages.

"The labour market remains tight and there has been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence and thus justifies a further forceful monetary policy response," the BoE said.

The BoE statement did not repeat unusual language from November which said rates were unlikely to need to rise as far as markets expected.

Market rate expectations have fallen since then, and after Thursday's decision showed investors expected rates to peak at just under 4.5% in August 2023, slightly lower than before.

Sterling weakened against the U.S. dollar after the decision, falling to around $1.23, and British government bond prices fell.

Only one policymaker, Catherine Mann, wanted a bigger rate rise this month on the scale of November's 0.75 percentage point increase - the BoE's largest in more than 30 years - to tackle what she viewed as increased inflation risks since November.

However two other policymakers, Silvana Tenreyro and Swati Dhingra, who had wanted a smaller rate rise in November, said it was now time to halt rate rises entirely, as the tightening so far was "more than sufficient" to get inflation back to target.

Yael  Selfin, chief economist at KPMG UK, said she expected the rate hike to end in the first half of 2023, with Bank Rate reaching 4%.

"Following this, we could see the Bank adopting a wait-and-see approach, with no change to base interest rate as inflation gradually eases during the rest of 2023, and the full impact of higher rates feeds through to lower activity," she said.

Cuts to interest rates could come as soon as 2024 as the government tightens its purse strings and the economy needs help after the expected recession, Selfin added.

GLOBAL RATE RISES

The BoE move follows the U.S. Federal Reserve's decision on Wednesday to raise its main rate by half a point, as Western central banks grapple with post-COVID labour shortages and the impact of Russia's invasion of Ukraine on energy prices.

The European Central Bank is set to raise interest rates for the fourth time in a row on Thursday, although by less than at its last two meetings.

BoE Governor Andrew Bailey, in a letter to finance minister Jeremy Hunt accompanying the decision, said the BoE forecasts suggested British inflation had reached its peak.

Official figures on Wednesday showed consumer price inflation fell to 10.7% in November from 11.1% in October. That 0.4 percentage point fall in the annual rate was the largest since July 2021.

Budget decisions in Hunt's November fiscal statement meant inflation in the second quarter of next year would be 0.75 percentage points lower than the BoE had forecast, but the longer-term impact would be minimal, the BoE said.

Last month the BoE said Britain was entering a long recession, and predicted the economy would shrink by 0.3% in the final quarter of this year.

Now it expects a fall of 0.1%, and for economic output in a year's time to be 0.4% higher than previously thought as a result of budget measures that offered short-term stimulus.

However, fiscal tightening further ahead would leave GDP levels in two years' time little changed from the BoE's November projections, and 0.5% lower in three years' time than it had forecast.