Bank of England raises UK interest rates by quarter point to 4.25%

The Bank of England has raised interest rates by a quarter of a percentage point to 4.25% in response to higher than expected UK inflation and signs that Britain’s economy was holding up better than feared.

In a fortnight of heightened unease in global financial markets, the Bank’s monetary policy committee (MPC) voted by a majority of seven to two to increase the base rate for the 11th time in a row.

It comes after an unexpected jump in the UK’s annual inflation rate in February to 10.4% from 10.1% in January, fuelled by food prices increasing at the fastest pace in 45 years. The Bank’s official target for inflation is 2%.

The Bank also said the outlook for the economy was slightly improved and it was no longer predicting a technical recession, where the economy shrinks for two consecutive quarters.

Central banks on both sides of the Atlantic have pushed ahead with rate increases despite fears over the collapse of Silicon Valley Bank and the Swiss-government brokered rescue of Credit Suisse by its rival lender UBS. The US Federal Reserve raised its benchmark interest rate on Wednesday by a quarter of a percentage point to a range of 4.75% to 5%.

In a move widely anticipated by City traders after the shock UK inflation increase, the MPC said growth in the British economy was holding up better than expected, as the nine-member rate-setting panel pushed up borrowing costs to the highest level since the 2008 banking crash.

However, it indicated that inflation was still expected to fall “sharply” over the coming months amid a decline in global energy prices, in a potential sign that the MPC’s most aggressive assault on inflation in its history could be near an end.

In a signal of its future plans, the committee said that if there were to be “evidence of more persistent pressures, then further tightening in monetary policy would be required”.

Threadneedle Street said the UK economy was now expected to grow slightly in the second quarter of the year, after previously forecasting a 0.4% drop in activity, suggesting that the recent sharp fall in global energy prices and extension of government support for gas and electricity bills would help to bolster spending.

In a judgment issued after Jeremy Hunt’s spring budget last week, it said the measures announced by the chancellor could help to increase the size of the economy by about 0.3% over the coming years. The extension of the government’s energy price guarantee, at £2,500 for an average household bill, would help real incomes remain broadly flat, rather than falling significantly.

The extension in the cap is expected to lower inflation by about one percentage point, while freezing fuel duty would contribute a further third of a percentage point drop compared with its previous estimates.

Economists have said the turmoil in the global banking system has potential to further weigh on the economy, reducing the need for further interest rate rises at a time when headline inflation is already expected to fall sharply.

Two of the MPC’s external members, Silvana Tenreyro and Swati Dhingra, voted against a rate rise, saying higher borrowing costs were weighing on the economy in a way that could bring forward the point at which rate cuts would be required.

It comes amid signs that an acceleration in wage growth since the Covid pandemic has juddered to a halt in recent months, despite continuing signs of labour shortages in several sectors of the economy. Economists have suggested weaker levels of wage growth could reduce the risk of persistently high inflation.

The Bank said it was closely monitoring the economic effect of the failure of SVB and UBS’s takeover of Credit Suisse, and would issue a full assessment in its next update on the economy, in May.

The central bank’s financial policy committee said it “judged that the UK banking system maintained robust capital and strong liquidity positions, and was well placed to continue supporting the economy in a wide range of economic scenarios, including in a period of higher interest rates”.