Bank of England Holds Rates for First Time in Nearly Two Years
By Paul Hannon
LONDON -- The Bank of England left its key interest rate unchanged for the first time since November 2021 amid signs that inflation is cooling and the U.K.'s economy is teetering on the brink of contraction.
The BOE's decision to keep its benchmark rate at 5.25% leaves it out of step with a number of other European central banks that have continued to raise their key rates at recent meetings of policy makers.
The pound weakened against the dollar, trading 0.8% lower shortly after the rate call.
Earlier on Thursday, the central banks of Sweden and Norway matched last week's move by the European Central Bank in raising their key rates by a quarter of a point to 4% and 4.25%, respectively. They both signaled a further increase was possible. By contrast, Switzerland's central bank surprised economists by leaving its key interest rate unchanged at 1.75%.
The Federal Reserve left its key rate unchanged Wednesday, though inflation is far lower in the U.S. than in the U.K.
The BOE decision to hold rates came a day after U.K. inflation unexpectedly fell in August to 6.7% from 6.8% in July, despite climbing energy prices. Core inflation, which excludes volatile food and energy prices, also fell to its lowest level since January.
Easing price pressures have also come amid a backdrop of very weak economic growth. The U.K. economy has stagnated since Russia's full-scale invasion of Ukraine in early 2022. Gross domestic product fell in July, and business surveys for August don't point to a significant rebound. Unemployment has been rising over recent months.
Nevertheless, with inflation still far above its 2% target, the BOE didn't rule out a further rise in its key interest rate. The Fed on Wednesday signaled it might raise its key rate again before the end of the year.
"Inflation has fallen a lot in recent months, and we think it will continue to do so," said BOE Gov. Andrew Bailey. "But there is no room for complacency. We need to make sure inflation returns to normal."
The decision to hold was approved by the narrowest of margins, with four of the nine rate-setters preferring an increase in the key rate to 5.5%. Most of those who joined Bailey in voting for holding agreed that the call was "finely balanced," according to a record of the two-day policy meeting.
Picking the moment at which rates have risen enough to bring inflation down, but not so much that economic activity suffers more than is needed to achieve that goal, can be difficult. Some central banks, including those of Australia and Canada, signaled a pause in recent months, only to start raising rates again.
"As you potentially approach the end of a tightening cycle, it becomes very difficult to judge the balance of risks," said Clare Lombardelli, chief economist at the Organization for Economic Cooperation and Development.
The OECD recently warned that inflation still has the potential to deliver unpleasant surprises, with a recent pickup in oil prices being just one development that could leave central banks with little option but to raise their key rates again.
Brent crude futures, the international energy benchmark, are on track to rise by 26% this quarter, having already climbed to about $95 a barrel. But the impact on inflation will depend on whether hard-pressed consumers will accept further price rises.
"With the eurozone and U.K. economies seemingly slipping into recession, European firms are soon likely to find it harder to pass on higher fuel costs to consumers," said Simon MacAdam, an economist at Capital Economics.
The OECD on Tuesday said it expected the BOE to raise its key rate to 5.5% this week and by a further quarter of a percentage point in November, keeping it at 5.75% for most of next year. By contrast, it expects no further moves from the Fed or the ECB until well into 2024.
The BOE says it has underestimated the scale and persistence of the U.K.'s inflation problem since consumer prices began to rise rapidly in mid-2021. It has asked former Fed Chair Ben Bernanke to conduct a review of its forecasting process, with the results due to be published in spring 2024.
The BOE started to raise its key rate in December 2021, three months before the Fed first moved to increase rates and seven months earlier than the ECB.
Over recent months, BOE policy makers have said that their key interest rate is already at a level that is damping demand and inflation, while much of the impact of previous rate rises has yet to be felt. In the U.S., interest rates on mortgages are fixed for between 15 and 30 years. But British mortgages typically carry a fixed rate for between two and five years, so a rising number of homeowners will see their monthly payments increase substantially over the coming years.
Most European countries have seen their economies stagnate since Russia's invasion of Ukraine as household spending power is squeezed by sharply higher energy and food prices and business confidence falters.
The U.K. economy was the only one of the four Western European countries making interest-rate calls Thursday to register growth in the three months through June, while Sweden saw a large decline in gross domestic product. The OECD expects the U.K. economy to grow by just 0.3% this year and 0.8% in 2024, compared with U.S. growth forecasts of 2.2% and 1.3%, respectively.
Explaining its decision Thursday, the BOE said there were "increasing signs" that its previous rate rises were having an impact on economic activity.
"Underlying growth in the second half of 2023 is likely to be weaker than expected," the BOE said.
While leaving its key rate unchanged, the U.K. central bank has also decided to increase the pace at which it will reduce the portfolio of government bonds bought during its efforts to boost inflation in the years between the global financial crisis and the end of the Covid-19 pandemic, a policy known as quantitative tightening.