The Bank of England is expected to announce its biggest interest rate increase in three decades Friday as it seeks to beat back stubbornly high inflation fueled by Russia’s invasion of Ukraine and the disastrous economic policies of former Prime Minister Liz Truss.
Economists expect the bank to boost its key rate by at least three-quarters of a percentage point, to 3%, after consumer price inflation returned to a 40-year high in September.
The interest rate decision is the first since Truss’ government announced 45 billion pounds (NZD$90 billion) of unfunded tax cuts that sparked turmoil in financial markets, pushed up mortgage costs and forced Truss from office after just six weeks. Her successor, Rishi Sunak, has warned of spending cuts and tax increases as he seeks to undo the damage and show that Britain is committed to paying its bills.
The rate increase will likely be the Bank of England's eighth in a row and the largest since 1992. It comes after the US Federal Reserve on Wednesday announced a fourth consecutive three-quarter point jump as central banks worldwide tackle inflation that is eroding living standards and slowing economic growth.
The UK central bank may opt to raise rates by as much as 1 percentage point to show it is serious about tackling inflation after facing criticism for being slow to react earlier this year, said Luke Bartholomew, senior economist at abrdn.
“The Bank of England will try to look through the volatility caused by the government’s policy and gas price movements, and focus on underlying inflation pressure,’’ Bartholomew said in a note to investors. “However, given the impact on household spending of such large inflationary moves, and the risk to inflation expectations, it adds a further complication to an already very difficult policy decision.”
Central banks have struggled to contain inflation after initially believing that price increases were being fueled by international factors beyond their control. Their response intensified in recent months as it became clear that inflation was becoming embedded in the economy, feeding through higher borrowing costs and demands for higher wages.
The war in Ukraine boosted food and energy prices worldwide as shipments of natural gas, grain and cooking oil were disrupted. That added to inflation that started last year when the global economy began to recover from the Covid-19 pandemic.
Europe has been particularly hard hit by a jump in natural gas prices after Russia responded to Western sanctions by curtailing shipments of the fuel.
The UK also has struggled as wholesale gas prices increased fivefold in the 12 months through August.
The British government sought to shield consumers with a cap on energy prices. But after the turmoil caused by Truss’ economic policies, Treasury chief Jeremy Hunt limited the price cap to six months instead of two years.
Meanwhile, food prices have jumped 14.6% in the year through September, led by the soaring cost of staples such as meat, bread, milk and eggs, the Office for National Statistics said. That pushed consumer price inflation back to 10.1%, the highest since early 1982 and equal to the level last reached in July.
Increases in the cost of tea bags, milk and sugar mean that even the “humble” cup of tea, which people across the country turn to when they need a break from the pressures of daily life, is getting more expensive, the British Retail Consortium said Wednesday.
“While some supply chain costs are beginning to fall, this is more than offset by the cost of energy, meaning a difficult time ahead for retailers and households alike,” said Helen Dickinson, the consortium's chief executive.
Truss’ failed economic plan made things worse, driving the pound to a record low against the dollar, threatening the stability of some pension funds and triggering predictions that the Bank of England would boost interest rates higher than expected. That increased mortgage costs as lenders repriced their products.
The economic turmoil is putting homeownership further out of reach for many young people, according to research released this week by Hamptons, a UK real estate agency.
Mortgage rates average around 6.5%, compared with 2% a year ago.
Against this backdrop, Bank of England Gov. Andrew Bailey said last month that policymakers “will not hesitate” to raise interest rates to return inflation to the bank’s 2% target.
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