Stock - Bank of England / BoE
The Bank of England. Britain’s economy will likely stagnate through to 2025, according to the BOE forecasts. Image Credit: Bloomberg

The Bank of England raised interest rates to a new 15-year high, warning that its fight against inflation may require tighter borrowing conditions for a prolonged period.

The UK central bank lifted its key rate a quarter point to 5.25 per cent on Thursday, a smaller hike than the half-point increase delivered in June. Investors and economists had expected the move and have priced in further increases this year.

Policy makers led by Governor Andrew Bailey left the door open to further action if inflation persists and added language saying their stance will remain “sufficiently restrictive for sufficiently long” to bring it back to the 2 per cent target.

The bank cut its forecast for growth over the next two years and raised its outlook for inflation over the medium term, signaling a bleak backdrop for the next general election, which must be held by early 2025. Prime Minister Rishi Sunak has so far backed the bank in its fight against inflation, making halving the rate of price increases one of his five key pledges this year.

The decision indicated a growing division on the nine-member Monetary Policy Committee about how the BOE should respond to indicators showing that wages and prices are rising too fast for comfort while activity in the economy is weakening.

Catherine Mann and Jonathan Haskel voted for a half-point hike. Swati Dhingra sought no change. The remaining six including Bailey and his deputies were in the majority and noted that their action will weigh heavily on households and businesses.

“Inflation is falling, and that’s good news,” Bailey said in a statement released Thursday by the BOE. “We know that inflation hits the least well off hardest, and we need to make absolutely sure that it falls all the way back to the 2 per cent target.”

The BOE maintained its guidance that “if there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required”, minutes of the meeting showed. It added a sentence suggesting that once the tightening cycle is finished, rates may remain elevated for some time.

“The MPC would ensure that Bank Rate was sufficiently restrictive for sufficiently long to return inflation to the 2 per cent target sustainably in the medium term, in line with its remit.”

Key indicators, especially wage growth, “suggest that some of the risks from more persistent inflationary pressures may have begun to crystalise”.

Money-market traders now see the BOE’s key rate peaking below 5.75 per cent by February, down from as high as 5.85 per cent before the decision. The move was spurred by the division on the MPC about the appropriate policy response on Thursday. Some traders who were holding out for a bigger half-point hike were also caught off guard.

The BOE kept its forecast that the Consumer Prices Index, which topped 11.1 per cent last year, will sink to 4.9 per cent in the fourth quarter of this year, suggesting Sunak will meet his promise.

The central forecast indicates the UK economy will avoid a recession ahead of a general election. However, the charts indicating the range of possible scenarios show there is still a significant risk of a contraction.

“The committee has decided to bring some of the upside risks of inflation from persistence into its modal projections, pushing up on this inflation projection in the medium term relative to the May report,” minutes of the meeting said.

Britain’s economy will likely stagnate through to 2025, according to the BOE forecasts. It expects gross domestic product to grow 0.5 per cent in both 2023 and 2024 and by 0.25 per cent in 2025. By the end of the forecast period in 2026, GDP will be 0.75 per cent lower than estimated in May.