Bank Rate increased to 0.25% despite Omicron fears

The Bank of England's Monetary Policy Committee has voted 8-1 to increase Bank Rate to 0.25%.

Related topics:  Finance News
Rozi Jones
16th December 2021
Bank of England BoE
"Following yesterday’s news that inflation has risen to a ten-year high of 5.1%, the Bank of England has opted to raise interest rates in order to bring soaring prices under control."

UK inflation soared to 10-year high of 5.1% last month, and economists had widely been predicting a rate rise by the end of 2021 before fears spread around the new Omicron variant of Covid-19.

In its latest minutes, the MPC said that "an increase in Bank Rate of 0.15 percentage points is warranted at this meeting".

A rate rise was unexpected this month and the MPC noted the "two-sided risks around the inflation outlook in the medium term", but agreed that some modest tightening of monetary policy is "necessary to meet the 2% inflation target sustainably".

Discussing Omicron, the MPC said that "global risky asset prices fell in response to this news but have since largely recovered".

Although the Omicron variant is likely to weigh on near-term activity, the MPC said its impact on medium-term inflationary pressures is "unclear at this stage".

The Committee continued: "The Omicron variant poses downside risks to activity in early 2022, although the balance of its effects on demand and supply, and hence on medium-term global inflationary pressures, is unclear. Global cost pressures have remained strong."

Bank staff have revised down their expectations for the level of UK GDP in Q4 by around 0.5% since the November Report, leaving GDP around 1.5% below its pre-Covid level, largely due to voluntary social distancing. The experience since March 2020 suggests that successive waves of Covid appear to have had less impact on GDP, although there is uncertainty around the extent to which that will prove to be the case on this occasion.

The MPC added: "The MPC’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework. The framework also recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. In the recent unprecedented circumstances, the economy has been subject to very large and repeated shocks. Given the lag between changes in monetary policy and their effects on inflation, the Committee, in judging the appropriate policy stance, will as always focus on the medium-term prospects for inflation, including medium-term inflation expectations, rather than factors that are likely to be transient."

At its November meeting, the Committee judged that, provided the incoming data, particularly on the labour market, were broadly in line with the central projections in the November Monetary Policy Report, it would be necessary over coming months to increase Bank Rate in order to return CPI inflation sustainably to the 2% target.

The MPC will review developments, including emerging evidence on the implications for the economy of the Omicron variant, ahead of the February 2022 Monetary Policy Report.

Frances Haque, chief economist at Santander UK, said: “The MPC’s decision was a surprise given recent speculation that the MPC would hold until further information on the Omicron variant was known. 

“However, as a result of the fact that the labour market is performing much better than expected given the end of furlough and that inflation has been surprising to the upside, it would appear that the MPC members felt an increase in Bank Rate was required sooner to help bring inflation back to target over the next 18 months.

“The next question now, is when will a further hike in rates materialise. The MPC has provided previous guidance that rate hikes will move in small increments, and they will be mindful of choking any recovery, particularly as growth forecasts are starting to be cut.”  

Rachel Winter, associate investment director at Killik & Co. commented: “Following yesterday’s news that inflation has risen to a ten-year high of 5.1%, the Bank of England has opted to raise interest rates in order to bring soaring prices under control.

"With Plan B kicking in this week and the festive spirit dampened, we are all experiencing a bit of déjà vu. Consumer confidence has taken a hit and spending has shifted from instore to online as more people remain at home. Although businesses have spent the last 18 months adapting to a multitude of coronavirus measures and are now much more well placed to operate remotely, the outlook for the first quarter of 2022 looks rather bleak."

Hinesh Patel, portfolio manager at Quilter Investors, added: “Despite this morning’s PMI data and the extraordinary rise in Covid cases the Bank of England’s clearly feels vindicated to raise interest rates just before Christmas. Given high, and rising, inflation, in part a result of the Bank’s communication missteps creating a de-facto weaker sterling policy, it clearly felt it could no longer stay on the accelerator pedal despite the risks that are now out there in the economy.

“The Federal Reserve’s actions yesterday created a conundrum for the BoE. If the BoE did not match direction of travel over the longer-term, an even weaker sterling would have compounded inflation further to make the cost of living crisis even more acute. The trick in the BoE’s favour, and clearly what it is banking on, is the ability to raise rates should the Omicron variation be less severe than expected whilst maintaining asset purchases – a move that would be contrary to the Fed’s actions. This would ultimately provide a smoother ride for market volatility and a way to defend the pound.

“Employment data ahead of the latest Omicron variant was robust and ahead of expectations so the situation isn’t grave just yet. Given early hospitalisation data from South Africa, the hope is the UK can match a similar trajectory which would undoubtable be positive given what the case numbers are showing. Should this continue we would view the current stance as a tester with the view the Bank could be prepared to step back in should the situation deteriorate. Remember, interest rates are still incredibly low so we would like to see Q1 2022 remaining very much live for further tightening from what we deem as excessively stimulative conditions. However, all of this depends on the path of Covid and employment recovery.”

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