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Bank of England raises interest rates to 1.25% | Interest rates

The Bank of England has raised interest rates for a fifth time in succession to tackle an inflation rate that is heading towards 11% amid soaring household energy bills.

In a move widely expected by City economists, the Bank’s monetary policy committee (MPC) voted by a majority to increase its key base rate by 0.25 percentage points to 1.25% in response to living costs rising at the fastest annual rate for four decades.

It also said it was ready to “act forcefully” if required, signalling further rate rises in the coming months.

In a downbeat assessment as the central bank attempts to navigate a narrow path between flatlining economic growth and surging inflation, Threadneedle Street now expects the economy to shrink in the second quarter while a further rise in household energy bills is expected to push inflation above 11% in October.

In a split decision, a minority of three members of the nine-strong MPC pushed for a larger, 0.5-point rise, amid growing unease over persistently high inflation as central banks around the world launch aggressive rate hikes to combat the rising cost of living.

The US Federal Reserve announced a 0.75-point rate rise on Wednesday – the largest single rise since 1994.

Stock markets tumbled on Thursday as investors feared that rising interest rates would curb growth and lead to recession. The FTSE 100 blue-chip index slumped 3.14% to a three-month low, and suffered its worst day since early March.

European shares also slid, and bonds prices weakened, after a surprise interest rate rise by Switzerland’s central bank, while on Wall Street the S&P 500 had fallen around 3% in early trading.

Reflecting fears about the rising cost of living as the Covid pandemic and Russia’s war in Ukraine drive up global energy prices, the MPC said it was ready to launch a tougher response to inflation remaining above its target rate of 2%.

“The committee would be particularly alert to indications of more persistent inflationary pressures, and would, if necessary, act forcefully in response,” it said.

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The committee made its decision on Wednesday afternoon, before the Fed announced its 0.75-point move, although global financial markets had already shifted by that time to anticipate a sharp rate rise from the American central bank. The Fed had previously guided Wall Street to expect a 0.5 point rise.

Nevertheless, the Bank of England’s decision to stick with a 0.25-point increase underscores concern over the strength of the UK economy after weaker growth readings in recent months, as the cost of living crisis erodes household spending power and businesses struggle with severe staff shortages and supply chain bottlenecks.

Highlighting the growing risk of a recession, the Bank sharply downgraded its growth forecast for the second quarter of the year, cutting its estimate from a 0.1% rise in GDP during the three months to the end of June to a 0.3% decline.

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Official figures showed that the economy unexpectedly shrank in April after a fall in March. Threadneedle Street said other “temporary factors”, including the Queen’s platinum jubilee bank holiday, were also likely to have weighed on growth.

British households have faced a surge in living costs this year, with inflation reaching 9% in April – the highest rate in the G7 group of wealthy nations – after a record increase in gas and electricity bills.

The Bank said Rishi Sunak’s £15bn cost of living support package for households struggling with their bills would probably boost the economy by about 0.3%, although it would also add 0.1 percentage points to inflation within the first year as it would help support strong consumer demand for goods and services.

Andrew Bailey, the Bank’s governor, said further increases in household energy bills expected this October would lead inflation to rise slightly above 11% in October. In a letter to the chancellor explaining the Bank’s response to inflation, he said a “succession of global shocks” were hitting the British economy.

“The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term,” Bailey said.

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