In their first meeting since the short and turbulent premiership of Liz Truss came to an abrupt end two weeks ago, the Bank of England’s rate-setting policymakers are expected to raise interest rates on Thursday by the largest amount since 1989.
Traders are betting that the central bank will lift interest rates three-quarters of a percentage point, ramping up its effort to tighten financial conditions and taking the bank’s key policy rate to 3 percent, the highest since November 2008. Some analysts, though, say the bank may surprise with a more modest half-point increase, which would match its two previous moves.
Through all the tumult in Britain the past few months, high inflation, as well as the threat of it lingering for longer than expected, has remained a consistent scourge for the central bank. The annual inflation rate topped 10 percent in September, the highest in four decades and five times the central bank’s target.
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Policymakers have said they are determined to bring inflation down to its 2 percent target and will use higher interest rates to do so. But that job is complicated because Britain’s economic outlook has worsened as rising energy bills, food costs and mortgage rates have squeezed consumers. This is likely to temper how high the central bank chooses to raise interest rates. In part, that’s because it takes time for rate changes to have an impact, and so there is a risk that Britain will experience tight financial conditions while in a recession, when households and businesses are least able to bear the additional economic pain.
The Bank of England “seems to be acutely aware of the dangers of over-tightening, and we think it may tolerate higher inflation as the lesser of two evils as we enter a recession,” analysts at HSBC wrote in a note to clients. “With that, the probability that hikes end in 2022 is increasing once again.”
It’s a challenge for many central banks, which are also raising interest rates quickly in the face of the highest inflation in decades and potential recessions. On Wednesday, the Federal Reserve raised rates by three-quarters of a percent and signaled that more increases were to come, though the pace of them will slow. Last week, the European Central Bank raised rates by three-quarters of a point as it said inflation could increase but heavily stressed that the economy was weakening. Around the world, many central banks are taking action to protect against rising prices and falling currencies.
When policymakers at the Bank of England last met six weeks ago, on Sept. 22, the central bank raised interest rates by half a point. There was a rare three-way voting split as policymakers debated how entrenched inflation was becoming. The next day, Ms. Truss’s finance minister, Kwasi Kwarteng, announced a series of unfunded tax cuts that provoked turmoil in the government bond market and set Britain’s fiscal policy on a collision course with monetary policy.
At the time, the central bank said it would need to have a “significant” response as it expected the tax cut and spending plan to add to inflationary pressures. Meanwhile, in another corner of the bank, staff intervened in the bond market, fearing for the country’s financial stability.
Two weeks ago, Ms. Truss resigned, and her successor, Rishi Sunak, has made it clear that he intends to take a different approach to public finances. Later this month, he and the chancellor of the Exchequer, Jeremy Hunt, are expected to announce tax increases and spending cuts alongside a plan to cut Britain’s debt levels. Some calm has been restored to financial markets, and pressure on the Bank of England to sharply raise interest rates has diminished.
But Britain’s outlook remains gloomy and uncertain. A plan to freeze energy bills, which will hold down the headline inflation rate, will last only until April. This winter, average energy bills are about twice as high as last winter, food inflation is at its highest in four decades and many households are looking ahead to sharp increases in their mortgage payments. With customers aiming to reduce spending, corporations are warning about lower profits, and many companies and services are facing disruption from ongoing labor disputes.