Interest rates are expected to quadruple within months after the Bank of England put up borrowing costs for the first time since Covid hit in a scramble to stave off runaway inflation.
Threadneedle Street’s surprise decision to lift the Bank rate from 0.1pc to 0.25pc came as it warned that Consumer Prices Index inflation could hit 6pc next year, the highest level since February 1992, in a major blow to the living standards of millions of people.
Financial markets and economists are now predicting three more rate rises in 2022, the first of them within weeks, with rates potentially rising to 1pc – their highest since 2009 – as early as next August.
The Monetary Policy Committee (MPC) chose to act despite fears that restrictions to limit the rapid spread of the omicron variant will hurl Britain into another recession. A record 88,000 daily Covid cases were reported on Thursday.
Paul Dales, chief UK economist at Capital Economics, said: “This move came despite the escalating Covid-19 situation and increases the chances that interest rates will rise to the level of 1pc priced into the markets for the end of next year.”
Andrew Bailey, Governor of the Bank of England, said policymakers are worried about “more persistent” inflation than previously expected as labour shortages help to push wages higher. He told the BBC: “We’re concerned about inflation in the medium term, and we’re seeing things now that can threaten that.”
The decision reverberated in currency markets as the pound jumped as much as 1.6 cents against the dollar to $1.3374 immediately following the decision. It also buoyed the share prices of banks squeezed by more than a decade of near zero interest rates. Lloyds rose 5pc or 2p to 46.35p, HSBC added 16.35p to reach 448.65p, and Barclays rose 3pc or 5.7p to 182.1p.
Minutes of the Bank’s meeting showed an 8-1 vote in favour of lifting interest rates from 0.1pc to 0.25pc, with Silvana Tenreyro, an external member, the sole dissenter.
The rise will increase the squeeze on around one in five homeowners with variable rate mortgages and comes months before the Chancellor’s £36bn national insurance raid hits millions of pay packets alongside a fresh surge in energy bills next April.
The dampening economic effect of the omicron variant was underlined by the Chartered Institute for Procurement and Supply surveys showing private sector growth slowing to a ten-month low in December.
But the Bank is also concerned over a tight jobs market and a record 1.2m vacancies, and suggested that omicron might even increase inflation if the new variant further stretches global supply chains. It said “a potential worsening of global supply chain disruption could push up inflationary pressures” while China’s zero-Covid policy could trigger renewed disruptions at factories and ports.
The majority of the MPC said there is a “strong case” to raise rates amid concerns that inflation could run out of control after reaching 5.1pc last month. Ms Tenreyro voted to wait to assess whether the recovery was “threatened materially” by omicron.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: “The MPC’s decision to hike before it knows the full extent of the economic damage wrought by the surging Omicron variant, underlines how worried it is about the outlook for inflation.”
The rise is the second surprise in as many months after the Bank blindsided markets in November by holding fire despite strong language in the build-up to the decision.
Holger Schmieding, an economist at Berenberg, said Andrew Bailey may be at risk of being labelled an “unreliable boyfriend” again”.
The decision comes after the US Federal Reserve speeded up the pace of its tapering of pandemic support and signalled as many as three interest rate rises next year after inflation hit the highest level since 1982.
Christine Lagarde, president of the European Central Bank, also warned that omicron is slowing growth while shortages of goods and workers will add to inflation.
“To cope with the current pandemic wave, some euro area countries have reintroduced tighter containment measures. This could delay the recovery, especially in travel, tourism, hospitality and entertainment,” she said, adding that consumer and business confidence are suffering.
“Shortages of equipment, materials and labour in some sectors are hampering production of manufactured goods, causing delays in construction and slowing down the recovery in some parts of the service sector.”