The Bank of England has unexpectedly pushed up interest rates to 5%, the highest rate in almost 15 years, as policymakers and the UK Government come under mounting pressure to control the cost-of-living crisis.
The move is set to deepen the mortgage crisis as borrowing costs are hiked up for the 13th time in a row.
The 0.5 percentage point increase was the sharpest increase since February, surprising economists who had been expecting a smaller hike of 0.25 percentage points.
Bank of England governor Andrew Bailey said: “The economy is doing better than expected, but inflation is still too high and we’ve got to deal with it.
“We know this is hard – many people with mortgages or loans will be understandably worried about what this means for them.
“But if we don’t raise rates now, it could be worse later.”
It follows a higher-than-expected inflation reading in May as continued price rises forced policymakers into action in a bid to bring inflation down to the 2% target.
It comes amid growing calls for the UK Government to do more to help mortgage borrowers who are set for a big jump in their monthly repayments.
Financial markets have predicted that interest rates will strike a high of 6% by early next year, amid warnings that 1.4 million mortgage holders will lose at least a fifth of their disposable income in additional repayments.
The central bank’s Monetary Policy Committee (MPC) said on Thursday that it made the decision to hike rates more sharply due to “the background of a tight labour market and continued resilience in demand”.
Seven members of the nine-person MPC opted for the increase to 5%, but two members called for rates to remain flat.
With the UK Government and Bank of England under rising pressure over their failure to rein in inflation, Prime Minister Rishi Sunak insisted he feels a “deep moral responsibility” to deliver on his pledge to halve inflation by the end of the year.
Chancellor Jeremy Hunt has also said the government will “stick to its guns” and urged patience for the bank’s rate rises to curb inflation.
But as inflation remains stubbornly high, there are fears this may be increasingly out of reach and the finger of blame is pointing at the government and central bank for failing to get the cost of living crisis under control.
Sunak, due to speak after the rates announcement on Thursday at an economy-focused PM Connect event in the south east of England, will tell business figures that halving inflation is his administration’s “number one priority” and that he wants to get back to the target of inflation being at 2%, less than a quarter of what it stood at last month.
In pre-briefed comments, Sunak is expected to say: “I feel a deep moral responsibility to make sure the money you earn holds its value.
“That’s why our number one priority is to halve inflation this year and get back to the target of 2%.”
The bank is tasked with keeping inflation as close to 2% as it can, and the best tool it has to do that when inflation is high is by raising the base interest rate.
Luke Bartholomew, senior economist at abrdn, commented: “While some investors had been speculating about the risk of a 50bps increase today, this decision will come as a shock for many in the market.
“The risk for the Bank of England in causing such as surprise is they end up looking panicked and increase uncertainty about the likely future path of interest rates.
“However, policy makers clearly feel that that the recent run of inflation data has been ugly enough to warrant such a large move to try to keep a lid on inflation expectations.
“It is increasingly difficult to see how the UK avoids a recession as part of the process of bringing inflation down - and today’s large rate increase will probably be seen in retrospect as an important milestone towards that recession.”
The rise has piled more pressure on mortgage-holders, as rates are already at close to 15-year highs.
Hunt has so far dismissed suggestions that ministers could intervene to assist homeowners with rising mortgage rates, though he is set to meet with lenders on Friday as pleas grow for more to be done.
He said he has spoken to consumer champion Martin Lewis, who on Tuesday said that a mortgage ticking time bomb is now “exploding” and that his previous warnings failed to be heeded.
In a statement following the bank's decision, the chancellor stated: “High inflation is a destabilising force eating into pay cheques and slowing growth - core inflation is higher in 14 EU countries and interest rates are rising around the world, but the lesson from other countries is that if you stick to your guns, you bring inflation down.
“Our resolve to do this is watertight because it is the only long-term way to relieve pressure on families with mortgages; if we don’t act now, it will be worse later.”
It comes as the average two-year fixed residential mortgage rate has surpassed 6%, according to data from Moneyfactscompare.
Moreover, expectations of where rates will peak have surged in recent weeks, with markets now anticipating a high of 6% by early next year and warnings that 1.4 million mortgage holders will lose at least a fifth of their disposable income in additional repayments.
Ministers appeared unable to give assurances to worried mortgage holders, with Transport Secretary Mark Harper saying there would be “no quick fix” to the current economic situation.
Harper said that the government continued to have confidence in bank governor Andrew Bailey, though there were reports that Hunt’s economic advisers have rounded on the Bank for failing to curb inflation.
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