The Bank of England raised interest rates to their prepandemic level on Thursday in an effort to combat rapidly accelerating inflation that has been worsened by the war in Ukraine.
The central bank raised rates by 0.25 percentage points to 0.75 percent, the third consecutive increase at a policy meeting, as it forecast that inflation would reach about 8 percent in coming months, and possibly rise higher later in the year. But the decision wasn’t unanimous as policymakers weighed the gloomier outlook for the British economy.
While the war has led to higher energy and commodity prices, pushing up the expected peak in inflation, it is also predicted to cut economic growth in Europe, including Britain. This creates a challenge for the bank. Its goal is to bring inflation, which hit 5.5 percent in January, down to its 2 percent target, but policymakers want to avoid cooling the economy too aggressively and knocking the nascent post-lockdown recovery off course.
“The global economy outlook had deteriorated significantly following Russia’s invasion of Ukraine in late February, and the associated material increase in the prices of energy and raw material,” the bank said in a statement.
For now, global central bankers are focused on taming inflation. On Wednesday, the Federal Reserve raised U.S. interest rates for the first time since 2018 and projected six more increases this year as inflation soars. Last week, the European Central Bank moved closer to raising its interest rates when it proposed an end date for its bond-buying program. On Thursday, Christine Lagarde, the president of the European Central Bank, said Europe was unlikely to return to prepandemic inflation patterns, which consistently undershot the bank’s target.
For Britain, and Europe as a whole, the economic ramifications of war come on the heels of an energy price shock that started last fall and just months after the economy regained its prepandemic size.
“The economy has recently been subject to a succession of very large shocks,” the Bank of England said on Thursday. “Russia’s invasion of Ukraine is another such shock.” If energy and commodity prices stay high, they will weigh on Britain’s economy.
“This is something monetary policy is unable to prevent,” the bank added.
The bank’s run of rate increases began in December, the first move higher in three and a half years. The rate had been 0.1 percent since March 2020, when the onset of the pandemic sent financial markets careening and the government first introduced lockdown measures.
On Thursday, the bank said it had raised interest rates in order to stop higher trends in pay and consumer prices from becoming stronger and entrenched.
The bank previously expected inflation to peak in April, when the government’s price cap on energy bills rises. But it now says inflation could be even higher later this year — possibly several percentage points higher because of energy prices.
Even as inflation gets further from the bank’s target, it is unclear how many more rate increases are coming. The central bank reiterated that “some further modest tightening” in monetary policy might be appropriate but added a caveat on Thursday, saying there are risks to this judgment depending on path of inflation.
The pound fell about 0.8 percent from its intraday high against the U.S. dollar after the policy announcement, as traders saw increasing hesitancy in the policymakers’ meeting minutes about tightening monetary policy. There was no longer a suggestion of increasing rates by 0.50 percentage points, which some policymakers had voted for in February, and there was increasing concern about the squeeze on household incomes.
The Bank of England “is being far more cautious than the Fed,” strategists at the Dutch bank ING wrote in a note to clients. “That is a reminder that the U.K., like Europe, is an energy importer and more susceptible to events in Ukraine.”
The Russia-Ukraine War and the Global Economy
The ING strategists still expect another rate increase in May, but said the bank might pause after that.
Before the war, there were already concerns in Britain about a cost-of-living crisis. Inflation was outpacing wage growth, energy bills were set to jump higher and tax increases are scheduled for next month. The government is under increasing pressure to reconsider its plans to raise taxes when it announces an update to the budget next week.
Russia’s invasion of Ukraine is “likely to accentuate both the peak in inflation and the adverse impact” on economic growth by “intensifying the squeeze on household incomes,” the central bank said on Thursday.
In February, the bank projected that its measure of households’ net income after taxes and inflation would shrink 2 percent this year from last year. The impact on incomes is “now likely to be materially larger” because of higher commodity prices, the bank said on Thursday.
Eight of the nine members voted for the rate increase. Jon Cunliffe, a deputy governor for financial stability, voted to hold interest rates at 0.5 percent because of the “very material negative impacts” on households from higher commodity prices. A broader assessment on this balance between higher inflationary pressures and the worsening outlook for household budgets is needed, he said, according to the minutes of this week’s policy meeting.
