The Bank of England raised interest rates for the second time in three months, putting the United Kingdom ahead of the rest of Europe and the U.S. in moving to a tame surging inflation that is squeezing consumers and businesses.
The key rate was boosted by the bank's monetary policy committee by 0.5% from 0.25%. Since the global financial crisis, it said it will stop investing the proceeds from maturing securities in the 875 billion pounds $1.19 trillion of U.K. government bonds it purchased to bolster the economy.
Consumer prices in the U.K. rose 5.4% in the year through December, the highest inflation rate in almost 30 years. The squeeze is only going to get worse with household energy prices going up by more than 50% in April and income taxes going to rise by 1.5% the same month.
The bank's decision comes a week after the U.S. Federal Reserve said it would end its own asset purchases in March and is likely to raise interest rates for the first time in more than three years. Monetary policymakers around the world are trying to contain inflation fueled by rising energy prices and supply shortages as the global economy recovers from the COVID-19 epidemic.
Despite record inflation, the European Central Bank doesn't plan to raise rates until 2023, blaming it on temporary factors. The economic recovery is strong enough for it to dial back some of its stimulus efforts over the next year. It also meets Thursday.
The Bank of England will raise its key rate three times this year, pushing the rate to 1% by August.
The inflation rate is below 2% and the bank promotes economic growth as a result of interest rates.
Higher interest rates increase how much borrowers pay on everything from home mortgages to credit card purchases, reducing spending and slowing price increases. In 2009, the Bank of England bought U.K. government bonds and corporate bonds held by financial institutions to pump money into the economy during the global financial crisis. After they had slashed interest rates to 0.5%, policymakers were forced to switch to asset purchases, limiting their ability to use interest rates to stimulate economic growth.
With rates near record lows, the bank continued to buy bonds during the shocks caused by Britain leaving the European Union and the Pandemic. It is now the biggest holder of U.K. government debt, owning 875 billion pounds $1.18 trillion of government bonds, known as gilts.
In August of last year, the bank said it would begin reducing its bond holdings once the key interest rate reached 0.5%, if appropriate given the economic circumstances. The bank said it would reduce the holdings gradually, initially by not investing the money it gets from maturing bonds. The bank said that sales of assets wouldn't begin until rates reached 1%.
ING economists Antoine Bouvet and James Smith said in a note to investors that the strategy contrasts with the Federal Reserve, which is likely to take a more staggered approach.
Despite this bolder start, the early phases of BoE's balance sheet reduction look manageable, they wrote. It will initially amount to a large, predictable, and recurrent buyer not turning up to buy gilts.