Quantitative Easing

Bank of England raises rates to 2.25%, despite likely recession

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LONDON — The Bank of England raised its key rate by half a percentage point to 2.25% on Thursday and said it would continue to “react forcefully” to inflation if necessary, even if the UK economy is probably already in a shallow recession.

The central bank cut its forecast for peak inflation to just under 11% from over 13%, following Prime Minister Liz Truss’ plan to cap energy prices, but warned the policy could create longer-term price pressures.

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Just hours after the BoE’s decision, new finance minister Kwasi Kwarteng said a promised payroll tax cut would come into effect on Nov. 6. He is due to make a budget statement to parliament on Friday outlining policies that economists say could cost more than $150 billion. pounds ($169 billion).

This government spending, likely to be largely financed by new borrowing, is a double-edged sword for the BoE, reducing the risks of a prolonged recession announced by the central bank last month, but strengthening the forces pushing inflation.

The BoE said the very near-term economic outlook had deteriorated, in part due to this week’s extra bank holiday to mark Queen Elizabeth’s funeral. Gross domestic product for the July-September quarter is now expected to decline 0.1%, compared to a previous BoE forecast for growth of 0.4%.

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Combined with a decline in production in the three months leading up to June, these two successive quarters of contraction meet the common definition of a technical recession.

The BoE was the first major central bank to start raising interest rates in the current tightening cycle. But it has lately fallen behind the pace set by the US Federal Reserve, which raised rates by three-quarters of a percentage point on Wednesday, pushing the pound to a 37-year low against the US dollar.

“While exchange rate commentary remains taboo for many MPCs, we believe there will be concerns about the inflationary consequences of further weakening of the pound,” said Andrew Goodwin, the Kingdom’s chief economist. United at Oxford Economics.

The pound fell against the dollar after the decision, but remained above the all-time low near $1.12 hit earlier in the day.

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Economists polled by Reuters last week had forecast a repeat of August’s half-point rate hike, but financial markets had bet on a three-quarter-point hike, the biggest since 1989, at the exception of a brief unsuccessful attempt in 1992 to support the pound sterling. .

UK government bond prices fell sharply, but investors reduced their rate hike expectations slightly. Futures show BoE interest rates hit 3.5% by the end of the year – a quarter point lower than before the decision – although they continue to set rates reaching 5% by mid-2023.

As usual, the BoE gave little indication of the magnitude of the likely rate hike in the coming months.

“If the outlook suggests more persistent inflationary pressures, notably due to stronger demand, the Committee will react forcefully, if necessary,” the BoE said, using a form of words similar to previous months for its policy intentions.

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DIVIDED COMMITTEE

The BoE’s monetary policy committee voted 5-4 to raise rates to 2.25%. Deputy Governor Dave Ramsden and outside MPC members Jonathan Haskel and Catherine Mann voted for a bigger increase to 2.5%, while new MPC member Swati Dhingra wanted a smaller increase to 2%.

The MPC also voted unanimously to cut the £838bn of government bonds held by the BoE by £80bn over the coming year, by continuing to let the bonds mature and by the through active sales, which will begin next month.

This is in line with the target she declared in August and makes the BoE the first major central bank to start selling bonds bought in more than a decade of quantitative easing.

UK consumer price inflation hit a 40-year high of 10.1% in July and fell to 9.9% in August. The BoE said it expected inflation to stay above double digits for several months after its October peak.

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In a planned letter to new Finance Minister Kwasi Kwarteng explaining why inflation was so far above the BoE’s 2% target, Governor Andrew Bailey said Russia’s invasion of Ukraine was a major cause, but that a surprisingly tight national labor market was another factor.

UK unemployment fell to its lowest level since 1974 in the three months to July at 3.6%.

On Friday, Kwarteng will give more details of the government’s budget plans, which are likely to include the scrapping of a previously planned rise in corporation tax, as well as the costs of energy subsidies for households and businesses.

“All things being equal…it will add to medium-term inflationary pressures,” Bailey told Kwarteng of the household cap, adding that the BoE would assess further measures in November.

Kwarteng said the government’s efforts to support growth would increase the economy’s room for non-inflationary expansion. ($1 = 0.8872 pounds)

(Reporting by David Milliken and Andy Bruce; Editing by William James, Farouq Suleiman, Hugh Lawson and Catherine Evans)

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