The Bank of England on Thursday surprised markets by raising its primary interest rate for the first time in three and a half years to combat a rise in inflation, despite the economic uncertainty posed by the rapid Omicron variant.
The Bank of England was the first major central bank to raise interest rates as inflation rose to its highest level in a decade, and the bank said it would not peak until April. Eight of the nine policy makers voted for a rate hike compared to just two in November. After the announcement, the pound jumped against the US dollar and rose more than 1 percent.
“There was some value in waiting for further information on the extent to which Omicron was likely to escape the protection of current vaccines and on the initial economic effects of this new wave,” politicians said according to the minutes of the central bank meeting. “However, there was also a strong argument for tightening monetary policy now” due to the strength of inflationary pressures in the economy.
Britain set a record on Wednesday for the reported number of cases of coronavirus – 78,610 – and the UK’s top doctor warned more records would be broken. The government has opposed imposing major restrictions on businesses and social life and is instead focusing on speeding up the rollout of booster vaccines and encouraging people to work from home. But now, There are Christmas parties and other gatherings voluntarily canceled in droves, gyms are asking for more public support and people are retiring to their homes.
For the Bank of England, the virus rise had threatened to delay politicians’ efforts to get interest rates going, especially if they judged the new variant posed a serious risk to the economy. In their statement, they highlighted the uncertainty, but said that in some scenarios, the spread of the new variant could exacerbate inflation.
“This is a surprising decision,” said Krishna Guha, a central bank analyst at Evercore ISI, because of the growing uncertainty surrounding Omicron. “But it reflects warning signs from the labor market and inflation expectations that there is a clear and current danger that overinflation may become entrenched in the UK.”
The Bank of England announced the rate hike the day after its huge bond buying program was due to close, bringing the total holdings of government and corporate bonds to £ 895 billion.
The Bank of England is far from alone in trying to deal with historically high inflation levels. In the United States, prices are rising fastest pace in almost 40 years.
On Wednesday, the Federal Reserve said it would cut back on its bond-buying program by more than it had previously announced, while politicians signaled that interest rates could rise three times next year. Inflation in the euro area is the highest it has ever been since the creation of the single currency. On Thursday, the European Central Bank said it would end its bond buying program from the pandemic in March, but expand an older, smaller stimulus program.
Paul Mortimer-Lee, deputy director of the National Institute of Economic and Social Research in London, said he was concerned that central banks were reacting too late to inflation.
“My concern is that it’s too late for this horse to leave the stable,” he said. In the UK and US, central banks “wanted to believe that inflation was transient and they did not want to believe what was right in front of their nose that it has spread,” he said. “Now they’re kind of woken up and they’re in catch-up mode.”
In early November, the Bank of England took the financial markets off guard by not raising interest rates after politicians signaled that high inflation was becoming a concern. At the time, they said they would wait for more information on whether the end of the government-funded leave program in September led to a rise in unemployment. But they added that a rate hike would likely be necessary in the “coming months.”
So far, data have shown an increase in the payroll, a continued decline in unemployment and record high vacancies. The labor market has reacted as politicians hoped, but inflation has risen away from their expectations, increasing pressure to raise interest rates.
The annual inflation rate rose to 5.1 percent last month, the highest since September 2011, the Office for National Statistics said Wednesday. Last month, the central bank predicted that inflation would reach 4.5 percent in November and only peak at 5 percent in April. On Thursday, the bank updated its projections. Inflation would remain at around 5 per cent through most of the winter and peak at around 6 per cent in April. The central bank aims for inflation of 2 percent.
“You have these awful numbers,” Mr Mortimer-Lee said of the inflation forecasts, “and the heaviest period of the year for wage negotiations is the first quarter.” There is already proof of that unions demand higher wage agreements in response to the decade-high level of inflation.
“This kind of figure is really what can remove inflation expectations,” he added. “And even though the bank knows it can do nothing about this first wave of prices, it has to try to stop it from falling into the second and third rounds,” such as unsustainable higher wages.
So far, the inflation risk has offset growth concerns as the end of the UK’s economic recovery is delayed. On Thursday, the central bank also cut its fourth-quarter growth forecasts by half a percent. By the end of this year, the economy would still be 1.5 percent smaller than its prepandemic size. The government’s latest initiatives and voluntary social distancing would weigh on the economy in the first quarter of next year, the bank predicted.
“Experience since March 2020 suggests that successive waves of Covid appear to have had less of an impact on GDP,” the report said. “Although there is uncertainty about the extent to which this will prove to be the case on this occasion.”
Prior to Omricron’s proliferation, the UK economy was already losing momentum as supply chain disruptions and product and labor shortages hampered business. In October, gross domestic product rose only 0.1 percent from the month before, when the housing and food industries declined. It seems to be getting worse as the hotel industry risks losing revenue during the crucial party period.
“The new Omicron variant is a significant new source of uncertainty for the outlook,” said Ambrose Crofton, a strategist at JPMorgan Asset Management, in a note to clients. But if spending is diverted to more goods instead of services, or simply delayed, allowing the economy to recover its lost output at a later date, “then further rate hikes will follow,” he added.
Jeanna Smialek contributed with reporting.