The Bank of England has announced its decision to increase the UK interest rate by a quarter of a percentage point to 4.25%. This decision has been made in response to higher than expected inflation and the signs that the British economy is performing better than anticipated. The Bank’s monetary policy committee voted by a majority of seven to two to increase the base rate for the 11th time in a row.

In February, the UK inflation rate rose unexpectedly to 10.4% from 10.1% in January, fuelled by an increase in food prices at the fastest pace in 45 years. This increase in inflation has prompted the Bank to raise interest rates. However, economists have stated that the 12th and final rate increase to 4.5% is still uncertain as inflation is expected to fall sharply over the next few months.

The Bank of England has now implemented the most aggressive tightening of UK monetary policy for decades, with rates having risen by 4.15 percentage points since December 2021. However, the Bank has left open the option of a further rate increase, but has stated that it will only take action if there are signs of “persistent pressures” from inflation.

The Bank’s governor, Andrew Bailey, has stated that there are signs that the price spiral is “peaking,” but that it is still far too high. Bailey is confident that inflation will come down sharply from the early summer onwards, but this has not yet happened. In an optimistic assessment, the Bank has stated that it is no longer forecasting a technical recession, and UK gross domestic product (GDP) is now probably on track to grow slightly in the second quarter of the year.

The Bank of England is closely monitoring the economic effects of the turbulence in the banking industry and has stated that it will issue a full assessment in its next update on the economy in May. Despite fears over the collapse of Silicon Valley Bank and the Swiss-government brokered rescue of Credit Suisse by its rival lender UBS, central banks on both sides of the Atlantic have pushed ahead with rate increases.

Economists have said that the turmoil in the global banking system has the potential to further weigh on the UK economy, reducing the need for further interest rate rises at a time when headline inflation is already expected to fall sharply. Two of the MPC’s external members voted against a rate rise, saying that higher borrowing costs were weighing on the economy in a way that could bring forward the point at which rate cuts would be required.

The Bank has said that the measures taken by the chancellor, Jeremy Hunt, in last week’s spring budget could help to grow the economy by about 0.3% over the coming years while limiting short-term inflation. The extension of the government’s energy price cap at £2,500 for an average household bill is expected to lower inflation by about one percentage point, while freezing fuel duty would contribute a further third of a percentage point drop compared with its previous estimates.

Assuming that trends continue, economists believe that a pause in rate hikes is likely in May. However, this is dependent on banking sector stability, and the Bank has reiterated that it has separate tools that are better suited to maintaining financial stability.

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