(Bloomberg) -- The Bank of England hiked its key interest rate as part of a package of measures to contain inflation that’s on course to top 7%, as policy makers came within a whisker of delivering an unprecedented 50-basis point increase.
The increase to 0.5% from 0.25% was supported by five of the bank’s nine policy makers. In a surprise move, four voted for a bigger hike, to 0.75%, an increase that has not been seen since the bank gained independence in 1997. All said further modest tightening would be needed in coming months.
Officials also signaled the start of a new era for the 895 billion pounds of bond holdings amassed over the past decade under quantitative easing, and unanimously voted to begin the process of shrinking the balance sheet.
The BOE will immediately stop reinvesting the proceeds of expired gilts, allowing more than 200 billion pounds to run off by 2025, and announced plans to offload the entire 20 billion pound stock of corporate bonds by the end of 2023.
“Some further modest tightening is likely to be appropriate in the coming months” if the economy evolves as the BOE expects, the rate-setting committee added.
Stressing its inflation-fighting mandate, the BOE said that “the remit is clear the inflation target applies at all times, reflecting the primacy of price stability in the U.K. monetary policy framework.”
BOE officials lifted their forecasts for the peak of inflation to 7.25% in April, more than triple the BOE’s 2% target. Inflation had previously been expected to peak around 6%.
They also said the labor market remains very tight. They sharply increased their wage-growth forecasting, predicting the underlying pace will hit 4.75% in the coming year. Higher energy prices added further pressure, while cost of living pressures will slow GDP growth.
Against that backdrop, four officials - Dave Ramsden, Michael Saunders, Catherine Mann and Jonathan Haskel - voted to boost rates by 50 basis points, seeing the need to act faster to curb inflation expectations. The majority, including Governor Andrew Bailey, opted for the 25-basis-point rise.
The increase marks the first back-to-back hike since 2004. Bailey will hold a press conference at 12.30 p.m. in London to explain the decision.
The U.K. central bank is leading the way in a global tightening of monetary policy, as institutions move to tackle a rapid acceleration of prices in the aftermath of pandemic lockdowns. The U.S. Federal Reserve is expected to unleash its own rapid tightening cycle this year, and there has been speculation that may include a 50-basis-point hike.
The decision also comes with the U.K. in the grip of a cost of living crisis, which will bite harder starting in April when higher taxes and energy prices hit consumers.
Despite the improved outlook for wages, the BOE warned that real household incomes, after adjusting for inflation and tax rises, will shrink both this year and next.
An hour before the BOE’s announcement, the U.K. energy regulator Ofgem said the energy bill for a typical household will rise 54%, or around pounds, in April.
While the BOE admitted the hike itself can do little to address those immediate price rises, they stressed it was necessary to anchor longer-term stability. The government is preparing a multi-billion pound package of measures to mitigate the impact of rising energy bills. The measures may also bring down the headline rate of inflation.
“The sharp rises in prices of global energy and tradable goods of which the U.K. is a net importer will weigh on real aggregate income and spending. This is something monetary policy is unable to prevent,” the BOE said.
The squeeze on incomes will drive unemployment up to 5%, from around 4% now, and lead to increased slack in the economy by the end of the forecast period. The economy is expected to return to its pre-pandemic level this quarter, with growth recovering from the hit from omicron restrictions in February and March.
After that, growth is expected to slow to “subdued rates”, with a slightly weaker outlook than in November due to the impact of the cost of living crisis.
The BOE currently forecasts inflation will be a little above target in two years’ time, and drop below their goal in three years. The projection is based on interest rates reaching 1.5% by the middle of next year, which suggests the BOE may not go that far.
An alternative scenario, based on energy prices following their futures curve, rather than remaining constant after six months, would lead to inflation dropping to around 0.75 points below target in two and three years’ time.
Markets have priced in steeper hikes since the forecast window was closed, and are close to pricing in a level of 1.5% by the end of this year. That would imply the biggest tightening of policy for any calendar year since 1997.
The BOE also said it would immediately halt the process of reinvesting the proceeds from expired bonds held under its QE program, the first step in reducing its mammoth 895 billion pounds of holdings.
That will start in March, when 28 billion pounds of gilts mature. The bank reiterated it will start considering accelerating the process by pursuing active sales once rates hit at least 1%.
The bank also said it will halt reinvestments of its 20 billion pound corporate bond plan, and design a programme for outright sales. That will see the entire stock unwound by towards the end of 2023 at the earliest.