BoE hikes rates for first time in 10 years

The Bank of England raised UK interest rates for the first time in more than a decade on November 2, hiking base rates by 25 basis points to 0.5%.

The Monetary Policy Committee (MPC) voted by a majority of 7–2 to raise the main landing rate for the first time since 2007, in a move that reversed the BoE’s decision of August 2016, when it eased monetary policy in the aftermath of the UK’s vote to leave the European Union.

The central bank expects interest rates to rise gradually over the next three years, and all members of the committee agreed “any future increases will be at a gradual pace and to a limited extent”.

Following the announcement, sterling slipped against the US dollar and the euro, to trade at $1.31 and €1.12, respectively – more than 1% lower than before the decision – while the two-year gilt dropped to 0.484% from 0.497%.

“The pound and gilt yields slid sharply on the back of the removal of the line that interest rates may have to rise faster than markets currently expect,” said Michael Hewson, chief market analyst at CMC Markets. “The removal of this line suggests any further hikes are likely to come much further out into 2018. This is about as much as a dovish hike as you can get.”

Jeremy Cook, chief economist at WorldFirst, said: “[The] MPC couldn’t come out and say ‘this is a one and done hike’, but these minutes are hardly supportive of a ladder in rates from here.”

The MPC found itself stuck between quickly growing inflation and weak economic growth, mostly caused by uncertainty surrounding Brexit. CPI inflation rose to 3% in September – up from the BoE’s 2% inflation target – with the MPC expecting it to peak above 3% in October, as the past depreciation of sterling and recent increases in energy prices continue to pass through to consumer prices.

The BoE expects inflation to fall back over the next year and, conditioned on the gently rising path of the bank rate implied by current market yields, approach the 2% target by the end of the forecast period.

The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of the referendum-related fall in sterling

Bank of England

“The MPC’s projections are conditioned on the average of a range of possible outcomes for the UK’s eventual trading relationship with the European Union. The projections also assume that in the interim, households and companies base their decisions on the expectation of a smooth adjustment to that new trading relationship,” the bank said in its monetary policy summary.

“The decision to leave the EU is having a noticeable impact on the economic outlook. The overshoot of inflation throughout the forecast predominantly reflects the effects on import prices of the referendum-related fall in sterling,” it added.

The BoE noted uncertainty associated with Brexit is weighing on domestic activity, which has slowed, even as global growth has risen significantly. It added that Brexit-related constraints on investment and labour supply appear to be reinforcing the marked slowdown that has been increasingly evident in recent years in the rate at which the economy can grow without generating inflationary pressure.

“As expected, the BoE increased interest rates by 25 basis points in a historic move. The key driver for the increase in interest rates was the central bank’s more downbeat view on the economy’s growth potential, with the inflation forecast broadly unchanged from August,” said Shilen Shah, bond strategist at Investec Wealth & Investment.

The last decade

Since the financial crisis of 2007–08, interest rates in the UK have always either gone down or remained unchanged. The last time the BoE intervened to change its monetary policy, in August 2016, it slashed rates – the first move since March 2009.

Back in 2009, the half-a-point reduction brought the key interest rate to 0.5% – the lowest level since the BoE was founded in 1964 and the sixth-consecutive cut since October 2008, when rates were 5%. At the same meeting, the central bank began its quantitative easing programme, buying government bonds and corporate debt to restart credit markets.

The announcement came in the wake of the financial crisis, amid the worst recession witnessed by the UK in two decades. In January 2009, the country officially entered a recession for the first time since 1991, after the economy shrank in Q4 2008 at the fastest pace seen for nearly 30 years.

In February 2008, consumer confidence hit a nine-year low, lenders reported an increase in repossessions as people struggled to meet mortgage payments and the BoE cut rates by a quarter of a point to 5.25%. In the coming months, inflation jumped to 3.3% as food and energy prices soared. Meanwhile, the housing market crashed, with prices falling at the fastest rate since 1991. The BoE continued to slash interest rates – to 3% in November and to 2% in December.

Manufacturing and services firms suffered their worst conditions in 16 years, and unemployment kept rising, with more than two million people out of work. Thousands of jobs were cut in the City and the financial sector teetered on the brink of collapse, with RBS posting a £28 billion loss in January 2009 and the UK government forced to bail out the banking industry.

Finally, in March 2009, the BoE entered unexplored territory by cutting UK interest rates to 0.5%. A historic low until August 2016, when the bank expanded its stimulus measures by cutting interest rates by 25bp and launching a fresh round of QE in an attempt to limit damage to the UK economy in the wake of Brexit.