Bank of England raises interest rates for the first time in a decade

The Bank of England's top economists today voted to raise its key interest rate, bringing to an end an extraordinary 10-year period without a hike despite internal dissent about its decision.

Seven members of the rate-setting monetary policy committee (MPC), including governor Mark Carney, voted in favour of a 0.25 percentage point hike in bank rate, to 0.5 per cent, the Bank announced today. The decision was widely anticipated by economists and markets.

In updated forecasts for economic growth, also released today, the Bank upgraded its forecast for 2017 GDP expansion, reflecting the moderate acceleration in the the third quarter. However, it said growth in 2018 will be slower than previously thought, at 1.7 per cent annually.

The members who voted for interest rates to rise said spare capacity has eroded “a little more rapidly” than expected, meaning further domestic inflationary pressure is likely to start soon, according to minutes from the MPC's meeting.

Inflation is now expected to have peaked at 3.2 per cent in October, owing mainly to the depreciation of sterling following the EU referendum in June 2016, as well as a more recent pick-up in oil prices.

Doves and hawks

Two members of the committee, Sir Jon Cunliffe and Sir Dave Ramsden, voted against raising rates, pointing to the weakness of wage growth which has troubled the Bank's economists even as headline inflation has surged past the Bank's two per cent target to reach three per cent in the year to September.

Wages have lagged behind price rises over the past year, squeezing consumers. The small rate hike announced today will add an average of £180 extra per year to mortgage payments, although the Bank will hope that will be offset by slower price rises.

The Bank emphasised that any further rate rises will be “at a gradual pace and to a limited extent”, but its conditioning assumptions for forecasts imply a further two hikes by the third quarter of 2020, a faster pace of tightening than assumed in August.

The majority in favour of a hike also judged that the improvement in global growth will aid the UK economy. Meanwhile the MPC notes growth has “rotated towards net trade and business investment and away from consumption”, albeit not enough to compensate for much lower consumer spending.

Productivity squeeze

The last time the Bank raised rates, on 5 July 2007, the economy was growing at a healthy rate, but since the financial crisis weak productivity has held back growth.

The decision to raise interest rates today comes despite a weaker productivity outlook. The Bank forecasts productivity growth will reach a longer-term average of 1.25 per cent to 1.5 per cent by 2020, the end of its forecast period, compared to the pre-crisis average of around 2.25 per cent.

The Bank argues that lower productivity has reduced the potential growth rate of the economy, meaning the MPC members feel they had to tighten monetary policy to stop inflation from rising further even though growth is lower.

The MPC also noted that “Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown” in the UK economy's growth potential. The Brexit vote is having a “noticeable impact on the economic outlook”, with “uncertainties” from the process dragging back domestic activity, the MPC's minutes said.

The Bank left its other monetary policy tools unchanged. The stock of UK government gilts bought under quantitative easing will remain at £435bn, while the stock of corporate bonds will remain at £10bn. There were also no changes to the term funding scheme to boost bank lending.

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