Stock - Bank of England / UK London Economy
The move comes a day after the US Federal Reserve raised its key interest rate by 0.75 percentage points. Image Credit: Bloomberg

London: The Bank of England raised interest rates to 3 per cent on Thursday from 2.25 per cent, its biggest rate rise since 1989 as it warned of a “very challenging” outlook for the economy.

The central bank forecasts inflation will hit a 40-year high of around 11 per cent during the current quarter, but that Britain has already entered a recession that could potentially last two years - longer than during the 2008-09 financial crisis.

Thursday’s decision - the biggest in 33 years apart from a failed attempt to support the pound on Black Wednesday in 1992 - was in line with economists’ expectations in a Reuters poll, but was not unanimous.

Two policymakers, Silvana Tenreyro and Swati Dhingra, voted for smaller increases of a quarter and half a percentage point respectively, as the economy was probably already in recession.

But the majority of the Monetary Policy Committee said rates would need to rise higher still, although probably not as high as the 5.2 per cent which was priced into financial markets when the BoE finalised its forecasts.

“Further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets,” the BoE said in unusually specific guidance to investors.

Just before Thursday’s policy decision, markets expected rates to peak at around 4.75 per cent.

“The Committee continues to judge that, if the outlook suggests more persistent inflationary pressures, it will respond forcefully, as necessary,” the MPC added.

Central banks across the Western world are responding to similar challenges. Inflation has rocketed over the past year due to residual labour shortages and supply-chain bottlenecks since the COVID pandemic and - in Europe’s case - a big increase in energy bills since Russia attacked Ukraine in February.

The US Federal Reserve raised its key interest rate by 0.75 percentage points on Wednesday to a range of 3.75-4.0 per cent, and the European Central Bank increased its deposit rate by the same amount to 1.5 per cent last week. The Fed said future rate rises might come in smaller steps.