The Bank of England raised interest rates by a quarter of a percentage point to 4.5 percent, as it warned it would not hit its inflation target until 2025.
A seven-to-two majority in the central bank’s Monetary Policy Committee said the hike was necessary to curb inflation as they took rates to their highest level since 2008.
The BoE revised its short-term inflation forecast significantly higher as it admitted it had previously underestimated the strength and persistence of food price increases.
Instead of inflation falling below its 2 percent target a year later, as it had previously predicted, the BoE now thinks it will hit the target as early as 2025, after the latest date of the next general election.
It now expects growth to fall to 5.1 percent in the fourth quarter of the year from the current rate of 10.1 percent, instead of the previous forecast of 3.9 percent. Any further deterioration in the inflation outlook would see UK Prime Minister Rishi Sunak lose his pledge to halve inflation by the end of the year.
However, the Bank now thinks the UK economy will avoid recession relatively comfortably, forecasting that gross domestic product by mid-2026 will be 2.25 percent higher than expected in February.
The BoE believes that food price inflation will no longer increase overall prices in a year. But it now expects a modest improvement in the economic outlook to mean inflation will remain above target later.
Financial markets expect the cost of borrowing to rise further, with rates close to 5 percent.
BoE forecasts did not push against such expectations and the MPC warned that “if there is more persistent evidence [inflationary] pressure, then monetary policy will need to be tightened.
It said the growth potential was boosted not only by lower energy prices but also by stronger consumer and corporate confidence and an increase in public spending in the March Budget.
BoE officials stressed that growth forecasts are still weak, with annual growth struggling to exceed 1 percent over the next three years while unemployment is expected to rise from 3.8 percent currently to 4.5 percent by 2026.
Households have not yet felt the main effects of a 0.1 percent rise in interest rates to 4.5 percent in December 2021, the BoE said in its monetary policy report, with only a third of the full impact.
MPC members Swati Dhingra and Silvana Tenrero, who voted to keep the rate at 4.25 percent, said the lingering effect of the previous hike was yet to come. They maintained that this was likely to push inflation down considerably, necessitating future interest rate cuts.
Sterling traded 0.2 percent stronger against the dollar at $1.26, down 0.5 percent before Thursday’s announcement. The pound has gained more than 20 percent since September.
Additional reporting by Daria Mosolova