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Bank of England becomes the first major central bank to hike interest rates since the pandemic

The Bank of England, in a surprise move on Thursday, raised the interest rates by 15bps making the bank rate at 0.25 percent, up from the previous 0.1 percent.

Doing so, it has become the first major central bank to increase interest rates in order to curb rising consumer prices since the pandemic began.

Source: Reuters

The Monetary Policy Committee (MPC) voted in the majority by 8-1 to lift interest rates to 0.25%, which is fairly surprising given the emergence of the Omicron variant and uncertainty over the near-term growth impact. 

The move came as a surprise to the many economists who anticipated no change, as they were left disappointed last month. It was expected that the central bank would intervene as inflation ticked upwards, with the figure crossing over 5 percent, the highest in the decade and 3x than the BoE’s target. 

Well, it’s better late than never.

The Bank in its central projections for November, expected the UK GDP to recover further from the effects of COVID-19 in the near term. As supply disruption eased and the global demand rebalanced, it expected the upward pressure on CPI inflation to dissipate over time. But, since November’s meeting, a new variant of the virus – Omicron emerged, which is more transmissible and spreading rapidly within the UK and around the world.

2021 already has been a difficult year for the UK with the pandemic and post-Brexit adjustments. Given the circumstances, plus when inflation is at a decade high, the labor market is tightened and the GDP is expected to decline, these factors were just too strong for the committee to ignore. It was imperative for the Bank to take action and overcome concerns about the drastic effects of the Omicron variant. The agenda has finally moved from pandemic recovery to fighting inflation. 

The International Monetary Fund would be happy too.

Earlier this week, the IMF issued a brief directive to BOE to get on with tightening. It said that the Bank needs to calibrate a response, taking into account both pressures coming from inflation and the necessity to make sure that it is not cold water thrown on growth.

On asking whether leaving the interest rates as it is till February with Omicron possibly causing a mild slowdown would be a good decision, Kristalina Georgieva, Managing Director of the IMF, responded, “We know that inflation was challenging before Omicron. It is possible that Omicron will add to the supply chain interruptions. We have a sense that supply chain interruptions are likely at a cost of about one percent for inflation this year, so if Omicron adds to more of this, that can be an inflationary factor. We already see that in the UK, we are projecting that inflation will pick up to five and a half percent in 2022.”

The BoE stunner made the banking stocks go up in London as the move was set to boost profits from lending and income earned by investing deposits. Barclays PLC rose 5.6%, Lloyds Banking Group PLC jumped as much as 6.9%, NatWest Group PLC gained 4.5% and HSBC Holdings PLC rose 3.8%. 

Among the other things that happened, the Pound Sterling rose nearly 1% versus the Dollar, being the highest since November 30. Also, the entire gilt yield rose by about eight basis points, rising by 0.58% on Thursday, the highest since December 1. 

Of more pressing importance is the fact that the bank expects consumer inflation to peak at around 6 percent in April 2022. The current inflation level is expected to remain around 5% through the majority of the winter period. 

These levels are, of course, higher than normal for the UK but then 2020 and 2021 also haven’t been very easy for the nation. People there are worried whether the inflation rates will return to levels the UK experienced in the 1970s. Even though the bank expects inflation to stay high over the coming year, it is confident that it will not get anywhere near those levels this time. 

The MPC has set monetary policy to meet the inflation target that the government has set for it – 2 percent. And to reach it sustainably, the UK may see further spikes in interest rates in the coming years. Experts predict an increase to 0.5% by March, and to 1% by September.

The recent spike in the Covid cases does not impede the central bank’s action on combating rampant price increases, at least for now. Something had to be done if there is to be any chance of containing inflation expectations and future wage demand.

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