Interest rates go up as Bank of England responds to inflation fears

Bank of England

Interest rates have been increased for only the third time in a decade as the Bank of England tries to curb rising inflation.

The Bank of England’s Monetary Policy Committee (MPC), which sets interest rates, voted 8-1 to increase the rate by 15 basis points to 0.25%.

Concerns over soaring inflation outweighed worries about the impact of Omicron on the economy, which threatens to suppress consumer demand.

The MPC said: “The labour market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures.

“Although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage.”

The MPC has a medium-term target of 2% inflation, but yesterday it was revealed inflation hit 5.1% last month, up from 4.2% in October. Rises in petrol and energy prices are driving costs up, with high inflation arriving months earlier than was expected around the time of Rishi Sunak’s Budget just seven weeks ago.

The Bank of England now expects inflation to remain around 5% through the majority of the winter and to peak at around 6% next April. Its forecast is based on the “lagged impact” on domestic energy bills of wholesale gas prices.

Laura Suter, head of personal finance at AJ Bell, said: “Rising inflation is the real reason behind this fast switch, with new figures out yesterday clearly causing a lot of concern at Threadneedle Street.

“The Bank has now increased its expectations for inflation and thinks it will hit 6% next April – which is unwelcome news for any household, which is no doubt already feeling the effects of rising prices and bills.

“While Omicron is still a worry for the Bank, rampant inflation is clearly an even bigger concern.”

The increase in interest rates to 0.25%, announced at lunchtime, ends 20 months of an historic rate low of 0.1%.

Interest rates, 2012-2021 (Credit: Bank of England)

The MPC added: “Bank staff have revised down their expectations for the level of UK GDP in 2021 Q4 by around ½% since the November Report, leaving GDP around 1½% below its pre-Covid level.

“Growth in many sectors has continued to be restrained by disruption in supply chains and shortages of labour. The impact of the Omicron variant, associated additional measures introduced by the UK Government and Devolved Administrations, and voluntary social distancing will push down on GDP in December and in 2022 Q1.

“The experience since March 2020 suggests that successive waves of Covid appear to have had less impact on GDP, although there is uncertainty around the extent to which that will prove to be the case on this occasion.”

Interest rate changes used to be a common feature of monetary policy, for example there were 24 rate changes in less than five years after Gordon Brown made the Bank of England independent in 1997.

But after a flurry of 10 rate cuts in 20 months during the global financial crisis of 2007-09, there was then a seven-year wait for the next one, which came in the wake of the Brexit referendum.

The two raises that followed, in November 2017 and August 2018, were both by a quarter-point.

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