The Bank of England (BoE) has raised interest rates by 0.5% as it looks to tame inflation and revive a falling pound, while warning that the UK is already in recession.
The dovish move pushes rates to 2.25%, their highest level since November 2008 – a near 14-year high.
Financial markets had expected a more hawkish hike of 0.75%, which would have marked the biggest increase in 33 years. However, it is still the seventh consecutive rise from the central bank.
Members of monetary policy committee (MPC) were split on the decision, voting 5-3-1 on the move.
Governor Andrew Bailey, Ben Broadbent, Jon Cunliffe, Huw Pill, and Silvana Tenreyro all voted to lift rates by half a percent, while Jonathan Haskel, Catherine Mann and Dave Ramsden pushed for a larger 75 basis point increase.
Swati Dhingra, the newest member of the committee, voted to only raise rates by 0.25%, which came under fire from Andrew Sentance, former BoE rate-setter.
He tweeted that she may not have understood the "severity of the current inflation surge".
Good to see 3 #MPC members - Haskel, Mann and Ramsden - voting for a 0.75 percent interest rate rise. Disappointing to see the newest #MPC member Swati Dhingra voting for a meagre 0.25 percent rise. Not sure she has got her head around the severity of the current inflation surge.
— Andrew Sentance (@asentance) September 22, 2022
Economists had priced in 200 basis points of increases over the next three decisions, implying a possible three-quarter point rise at the next two meetings. They had also predicted that rates could reach 3.75% by the end of the year.
“Hawkish surprises from the MPC have been far less common than dovish ones over the last year," Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said.
"In addition, governor Bailey openly referred to a 50bp hike ahead of the August meeting, but had not given markets a nudge to price-in a 75bp hike.
"We think that the MPC still will deem a 50bp increase to be consistent with its pledge to act 'forcefully', if it sees signs of more persistent inflationary pressures."
Meanwhile, the Bank also decided to start unwinding its stock of UK government bonds, which had been built up through its quantitative easing programme following the financial crisis, and then the COVID-19 pandemic.
It will reduce the stock of purchased UK government bonds by £80bn over the next 12 months, to a total of £758bn.
Watch: What to Watch for in BOE Rate Decision
It comes as inflation is almost five times above the Bank’s 2% target, at 9.9%, with forecasts set to rise further.
According to the Office for National Statistics (ONS) earlier this month, the UK’s rate of inflation eased in August after registering a double digit increase for the first time in more than four decades the month before.
This was below economists’ expectations, however core prices, which exclude volatile items like energy and food, ticked up to 6.3% from 6.2%, suggesting price rises are firmly embedded across the economy.
On Thursday, the BoE lowered its forecast for inflation, due to prime minister Liz Truss's energy price freeze.
It now predicts that CPI inflation is likely to peak in October at just under 11% instead of the 13% forecast last month.
"Nevertheless, energy bills will still go up and, combined with the indirect effects of higher energy costs, inflation is expected to remain above 10% over the following few months, before starting to fall back," it said.
The Bank is also under pressure to help boost sterling, which is trading at its lowest level against the dollar (GBPUSD=X) since 1985, and is on track for its worst year since the financial crisis in 2008.
There are also growing concerns over the British economy as GDP growth is slowing down, following a decline in UK retail sales.
The BoE downgraded growth forecasts, and now predict that the British economy shrank by 0.1% in the third quarter of the year. This follows a 0.1% drop recorded in three months to June, and would be the second quarterly contraction in a row, marking a technical recession.
It pledged to act "forcefully" to tame inflation, and that it would assess the impact of Kwasi Kwarteng's mini-budget in time for its next interest rate decision in November.
Watch: What is a recession and how do we spot one?
Last night, the US Federal Reserve also made a hawkish move after delivering its third consecutive rise, lifting interest rates by another 75 basis points and taking them to a post-financial crisis high.
Chair Jerome Powell said the central bank would keep tightening rates to push down inflation, and that he would not rule out a recession.
The European Central Bank (ECB) also raised interest rates by 0.75 percentage points this month for the first time since the launch of the euro. It had come under criticism for being behind the curve and acting too slowly on inflation.
Elsewhere, Sweden's central bank raised rates on Tuesday by a larger-than-expected full percentage point, while the Swiss National Bank lifted its key interest rate by 75 basis points, from -0.25% to 0.5%. This brought rates back into positive territory for the first time in eight years.
"The MPC will feel its hand was forced. The new Tory government is opening the fiscal taps, while on the other side of the pond, the Federal Reserve is tightening the monetary screws," Charlie Huggins, head of equities at Wealth Club, said.
"Both factors have compounded pressure on sterling, which is trading at its weakest level against the dollar since 1985. A weak currency only fans the flames of inflation, given the UK’s reliance on imports.
"The Bank of England is stuck between a rock and a hard place. A gentler approach to rate rises risks sending sterling into a tailspin, and seeing inflation get even further out of control. But too much tightening could easily choke the life out of the economy, without significantly easing the cost-of-living crisis. It’s a horrible balancing act, with seemingly no good outcomes.”
It came amid a warning that UK households would have faced a £3.1bn hit in extra mortgage costs with a 0.75% rate rise.
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: “For anyone who is already struggling with runaway price rises, the extra cost of the mortgage could be the final straw.
“While anyone with a fixed rate is currently protected, all these rate rises will be adding up and hit them in one fell swoop when it’s time to remortgage.
“If you have less than six months left to run on your mortgage deal, it makes sense to lock in a new fixed rate as soon as possible, ahead of potential rate rises.”