The Bank of England (BoE) has raised its benchmark interest rate from 0.1% to 0.25%, in its first rate hike since August 2018.

Meeting in London today, the BoE’s Monetary Policy Committee (MPC) voted overwhelmingly for the rate hike in an 8-1 vote.

On quantitative easing, the MPC also voted unanimously to maintain the BoE’s current stock of UK government bond purchases at £875 billion, with a total target stock of asset purchases at £895 billion.

Lastly, the MPC voted for the BoE to maintain its stock of sterling non-financial investment-grade corporate bond purchases at £20 billion.

Sterling reacted positively to the news, with GBP advancing 0.78% against the US dollar at the time of writing, and up 0.38% against the euro.

UK bank stocks also moved higher on news of the rate hike, with Barclays up 4.44%, Lloyds up 5%, Standard Chartered up 4%, and HSBC up 3.56% at the time of writing.

Inflation biting

Among the MPC’s reasons for issuing its first rate hike in more than three years, taking back control of inflation was top of mind. 

In its summary of today’s meeting, the MPC said it had been caught off-guard by the UK’s persistently high inflation prints in Q3 and Q4 this year, with inflation rising faster than the bank had anticipated.

After a decade-high inflation last month, the MPC said the BoE now expects the consumer prices index (CPI) to hit 6% next April, when the cap on energy bills is lifted. 

“Twelve-month CPI inflation rose from 3.1% in September to 5.1% in November, triggering the exchange of open letters between the Governor and the Chancellor of the Exchequer that is being published alongside this monetary policy announcement,” said the MPC.

“Bank staff expect inflation to remain around 5% through the majority of the winter period, and to peak at around 6% in April 2022, with that further increase accounted for predominantly by the lagged impact on utility bills of developments in wholesale gas prices.”

It is worth bearing in mind here that one of the BoE’s main targets, handed down to it by the UK government, is to keep inflation at below 2% annually.

With the bank now admitting that next year’s print could exceed its target three-fold, the MPC had to concede that it no longer has strong grounds for not taking decisive action against inflation with an interest rate hike.

Employment jitters

On unemployment, the MPC said the British labour market has responded positively to the end of the furlough scheme in September, with the unemployment rate seen declining again to 4.2% earlier this week.

Against ths backdrop of a “robust” labour market, the MPC judged that a rate hike would not negatively affect the UK economy at present.

“The labour market is tight and has continued to tighten, and there are some signs of greater persistence in domestic cost and price pressures,” said the MPC. 

“Although the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this stage.”

Market sentiment

After failing to deliver a rate hike at its last meeting in November, the MPC’s decision came as surprise to some observers, who had expected the bank to maintain the status quo.

Suren Thiru, head of economics at the British Chambers of Commerce (BCC), said he was surprised that the MPC has chosen to raise rates amid “mounting uncertainty” over the economic impact of the Omicron variant.

“While policymakers are facing a tricky trade-off between surging inflation and a stalling recovery, with the current inflationary spike mostly driven by global factors, higher interest rates will do little to curb further increases in inflation,” he said. 

“Instead, it is vital more than ever that the Government’s Supply Chain Advisory Group and Industry Taskforce start to provide some practical solutions to the supply and labour shortages that are continuing to stoke inflationary pressures.

“Without real improvement to the situation supply chains are currently facing, rising prices will continue to be an issue, even with monetary policy responses.

“While today’s rate increase may have little effect on most firms, many will view this as the first step in a longer policy movement – not as a partial reversal of last year’s cut,” he added.