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Bank of England announces biggest interest rate hike in 27 years

·Business Reporter, Yahoo Finance UK
·6 min read
Governor of the Bank of England, Andrew Bailey
The Bank of England has hiked interest rates for the sixth time in a row. It is biggest interest rate hike in 27 years since the Monetary Policy Committee (MPC) was set up back in 1997. Photo: PA

The Bank of England (BoE) has hiked UK interest rates by 50 basis points to 1.75% as it looks to combat runaway inflation, which it predicts will hit 13% later this year.

It marks the sixth consecutive increase from the central bank, and biggest interest rate hike in 27 years since the Monetary Policy Committee (MPC) was set up back in 1997. Interest rates are now at their highest level since December 2008.

The MPC voted 8-1 on Thursday, with Silvana Tenreyro the lone dissenter, voting for a smaller rise to 1.5%.

The move was widely expected by economists and financial markets, and comes amid mounting pressure to pick up the pace of interest rate rises.

The BoE raised interest rates to 1.75% on Thursday. Source: Bank of England
The BoE raised interest rates to 1.75% on Thursday. Source: Bank of England

What does this mean?

The BoE has the undesirable task of battling inflation while trying not to impact the British economy in a harmful way.

Threadneedle Street has until now raised interest rates in 0.25 percentage point increments since December 2021, but pledged in June to act more “forcefully” in response to more persistent inflationary pressures.

UK inflation hit 9.4% in the year to June, partly due to a 42% year-on-year increase in petrol prices, and an increase of almost 10% in food prices.

The Bank now expects inflation to peak to 13% before the end of the year — well above its 2% target — and for it to remain elevated in 2023.

Read more: How Bank of England’s interest rate rise will affect mortgages and house prices

Earlier in the week BoE governor Andrew Bailey said: “The committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary, act forcefully in response. Bringing inflation back down to the 2% target sustainably is our job, no ifs or buts."

The Bank also revealed plans to start selling the £850bn ($1tn) mountain of government debt amassed through a bond-buying programme during the pandemic and financial crisis.

Watch: What is a recession and how do we spot one?

What is the Bank saying about recession? 'Horror forecast'

It has also predicted that the UK will fall into recession in the last three months of this year, as well as contracting through next year. Lasting for five quarters, this would be the longest recession since after the 2008 financial crisis.

"Inflationary pressures in the United Kingdom and the rest of Europe have intensified significantly since the May monetary policy report and the MPC’s previous meeting. That largely reflects a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs," the Bank said on Thursday.

It added: "The United Kingdom is now projected to enter recession from the fourth quarter of this year. Real household post-tax income is projected to fall sharply in 2022 and 2023, while consumption growth turns negative."

Chart: Fitch ratings, ONS, Haver Analytics
Chart: Fitch ratings, ONS, Haver Analytics

Laith Khalaf, head of investment analysis at AJ Bell, described the Bank's recession warning as a horror forecast. “Winter is coming, and it’s shaping up to be an absolute horror show for the UK economy. Make no mistake, 0.5% is a historic interest rate rise, but it is overshadowed by the abysmal economic forecasts produced by the Bank of England.

"Inflation is now forecast to hit 13% at the back end of this year, when the UK is also expected to enter into recession, just in time for Christmas. Inflation is then expected to remain elevated into next year, and still be over 9% in the third quarter of 2023.

“The Bank’s frightening forecasts have shifted to a shocking extent in just three months. The UK economy is predicted to shrink by 2.1% over the next year, more than double the 0.8% contraction envisaged by the Bank as recently as May. Every time we hear from the Bank of England these days, it thinks inflation is going to go higher, and last longer than its previous estimates," Khalaf said.

UK inflation
UK inflation

How will this impact you?

Many households will be now squeezed further due to the interest rate rise, including some mortgage-holders. Lenders might also be looking at increases to unsecured loan rates.

The BoE is estimating that around two-fifths of mortgages will go up over the next year, so more people will be having to make higher monthly payments.

Read more: How interest rates are affecting UK mortgages

For example, a homeowner with a £250,000 tracker mortgage on a 25-year term will be paying an extra £62 a month after today’s announcement.

"The hardest hit will be those remortgaging, coming from period of historic low rates to a much less competitive market; an increase to this extent could mean a monthly increase of hundreds of pounds in real terms." Nick Leeming, chairman of Jackson-Stops, said.

People with other types of borrowing, including credit cards, personal loans and overdrafts, are also likely to see a potential increase in the cost of borrowing.

Watch: Will UK house prices ever fall?

“Unfortunately, policy tightening will inevitably take its toll on the UK economy," Seema Shah, chief strategist at Principal Global Investors, said. "Higher mortgage payments and borrowing costs will only add to the awful cost of living crisis, straining household budgets in a way we haven’t witnessed for over 60 years and plunging the UK into recession later this year."

Should we expect a further rate rise in September?

Financial markets have pencilled in another 25bp hike in September, with some predicting a pause after that.

Nicholas Hyett, investment analyst at Wealth Club, said: "Markets still think the Bank has a rate rise or two in the tank, but to some degree UK monetary policy is now caught in global forces over which the Bank has little control.

"Inflation will rise or fall according to what happens in Ukraine not Threadneedle Street, and rate decisions are dictated by moves at other central banks as much as by the MPC.”

Bailey said at the press conference on Thursday that all options will be on the table when the MPC meet again next month.

Watch: How does inflation affect interest rates?