European stock markets gave up their gains on Thursday as investors weighed up the Bank of England (BoE) increasing interest rates to 1%, and its warning that the UK may be heading for recession.
The members of the bank’s monetary policy committee (MPC) voted 6-3 to raise the Bank rate by a quarter-point, as widely expected, despite worrying signs that the economy is slowing.
Catherine Mann, Jonathan Haskel and Michael Saunders all called for a bigger increase to 1.25% to combat runaway inflation, which hit a fresh 30-year high of 7% last month, well above the Bank’s 2% target.
The Bank said the UK would avoid a technical recession, but that output will collapse by close to 1% in the final quarter of this year as the cost-of-living crisis continues.
In 2023, GDP is expected to shrink by 0.25pc, it said.
Becky O'Connor, head of pensions and savings at Interactive Investor, said: "The economy is tilting on its axis and a return to a higher interest rate environment means relearning old, forgotten rules for savers, borrowers, and investors.
“The last time rates were at 1%, the economy was responding to the financial crisis. Then, rates were heading down. Now we’re in a cost-of-living crisis and they are heading up.
"What will make the navigation of a rising rate environment even harder is that inflation, for now, remains high. It is yet to be seen whether higher rates will have the desired effect of bringing down inflation. Until it does, some people who are already struggling will feel like higher borrowing rates and rising living costs is a double whammy they just can't cope with."
Fitch Ratings said 50bps hike is not surprising. Chief economist Brian Coulton said: “While we have now had four hikes in a row, the fact is that interest rates remain such a long way below neutral that it’s hard to see the tightening to date doing very much to dent demand. A risk here is that the real wage squeeze has less of a dampening impact on consumer spending and core inflation than the MPC is assuming and that they will have to carry on tightening for quite a while.”
Watch: How does inflation affect interest rates?
Financial stocks such as banks and insurers gained ground on Thursday amid optimism about the higher-rate environment, while the pound has been under pressure lately amid concerns about a growing risk of recession.
Across the pond, the S&P 500 (^GSPC) slumped 3% at the time of the European close, and the Nasdaq (^IXIC) tumbled more than 4%, as tech stocks were the biggest fallers of the day. The Dow Jones (^DJI) edged 2.6% lower.
It came after the Federal Reserve lifted interest rates by 50bps as expected on Wednesday, pushing the upper bound of the funds rate to 1%.
It was the biggest interest rate rise in 22 years, however it played down any chance of a huge 75 basis-point lift in the near future.
The central bank also laid out the start of the balance sheet reduction program starting with $47.5bn (£37.9bn) in June, rising to $95bn a month after three months.
“This policy stance was much less aggressive than some of the more hawkish scenarios that the markets had feared, helping to act as a drag on the US dollar, pulling it back sharply from its 20-year highs, while yields also fell back sharply, especially at the short end,” Michael Hewson of CMC Markets said.
It came as US mortgage rates climbed to the highest level since August 2009 on Thursday. The average for a 30-year loan jumped to 5.27pc from 5.1pc last week, according to mortgage loans company Freddie Mac.
Sam Khater, chief economist at the company, said: "While housing affordability and inflationary pressures pose challenges for potential buyers, house price growth will continue but is expected to decelerate in the coming months."
Asian stocks were mixed overnight following the news from the US central bank, and as traders returned from an extended break this week.
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