Bank of England rate hike says ‘too soon to declare victory’

"We have done a lot on rates already … but it is too soon to declare victory just yet," bank Gov. Andrew Bailey said at a news conference. "Inflationary pressures are still there … and we need to be absolutely sure that we really are turning the corner on inflation."

Even so, the bank moderated expectations for further rate increases, dropping suggestions that it would respond "forcefully” to price pressures and implying that future moves would be smaller. Getting rid of that language was intentional and designed to send a signal to financial markets, Bailey said.

Central bankers worldwide are struggling to balance competing economic demands as they try to rein in inflation, which erodes savings and increases costs for consumers and businesses, without unnecessarily hurting economies that are still recovering from the effects of the COVID-19 pandemic.

The Federal Reserve has started tapering its response, boosting its key rate by just a quarter-point Wednesday. The European Central Bank, meanwhile, went big again Thursday, approving another half-point increase.

Economists had previously suggested that the Bank of England’s decision Thursday would be the last big rate increase after inflation slowed to 10.5% in December from a 41-year high of 11.1% two months earlier.

The bank said the outlook for Britain's economy is better than it was three months ago, with a steep decline in natural gas prices expected to reduce the squeeze on consumers and investment.

It expects inflation to fall sharply in the second half of this year and keep dropping to below the bank's 2% target by June 2024.

As a result, the bank says Britain is likely face a less severe recession than previously forecast, with the overall size of the economy shrinking less than 1% over the next two years. A recession is often defined as at least two consecutive quarters of declining economic activity, though economists differ on how to measure it.

"This is nevertheless a much shallower decline than expected” in November, Bailey said. "The projected downturn in the economy, while still technically a recession by common definition, is now significantly milder than past recessions."

The International Monetary Fund said this week that the U.K. was on track to be the only major economy to shrink this year, even as the outlook for the rest of the world improves.

Higher interest rates tend to crimp price rises because they increase the cost of mortgages, credit cards and other loans. But that also reduces demand for goods and services, slowing economic growth. The impact of rate hikes takes months to filter through into the wider economy, so policymakers have to make educated guesses about when to moderate their intervention.

Bailey warned that further rate increases would be needed if inflation turned out to be more persistent than expected, adding that there was plenty of uncertainty around the bank's forecasts.

Of particular concern is the price of natural gas.

Wholesale gas prices in Britain soared to record highs last year as Russian President Vladimir Putin curtailed supplies to Europe to punish the West for supporting Ukraine. While prices have dropped 75% from their peak in late August, predicting energy prices is notoriously difficult, especially as the war persists.

The rise in energy bills has helped lead to the U.K.'s biggest drop in living standards since the 1950s. That has triggered a wave of strikes — including the biggest day of industrial action in more than a decade on Wednesday — as nurses, train drivers, border guards and teachers demand pay increases that keep pace with inflation.

The government has spent billions to help consumers and businesses hit by high energy costs this winter, which has squeezed public finances. Officials also are trying to prevent higher wages from causing a second round of domestically driven inflation that could be more difficult to tamp down.

The central bank also highlighted concerns about a shortage of workers, which is feeding through into rising wages, and the impact higher interest rates may have on economic activity.

"For now then, it looks like the Bank is erring on the side of caution when it comes to inflation, but that comes with the risk of pressuring businesses and consumers more than is necessary,'' said Laith Khalaf, head of investment analysis at financial services company AJ Bell.