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The Bank of England building, in London, on Dec. 16, 2021.TOBY MELVILLE/Reuters

The Bank of England raised interest rates to 0.5 per cent on Thursday and nearly half its policy makers wanted a bigger increase to contain rampant price pressures, which the British central bank warned would push inflation above 7 per cent.

In a surprise split decision, four of the nine Monetary Policy Committee (MPC) members wanted to raise rates to 0.75 per cent in what would have been the biggest increase in borrowing costs since the BoE became operationally independent 25 years ago.

But a slim majority, including Governor Andrew Bailey, voted for a 0.25-percentage-point increase.

The pound briefly jumped above US$1.36, its highest level since Jan. 20, and touched a two-year high against the euro. British government bonds sold off, with the 10-year yield at its highest since January 2019.

Mr. Bailey told investors not to assume the BoE was embarking on a long series of rate hikes, and said there would be a trade-off between strong inflation and weakening growth as many households see their incomes squeezed.

Earlier, Chancellor of the Exchequer Rishi Sunak detailed measures to help households cope with a leap in energy prices in April, when taxes for workers and firms are slated to rise.

Mr. Bailey said he had a “hard message” for the public.

“We have not raised interest rates today because the economy is roaring away,” he told reporters. “An increase in Bank Rate is necessary because it is unlikely that inflation will return to target without it.”

Britain is facing an “extreme example” of an economic shock that would raise the cost of living for everyone, Mr. Bailey warned.

Some analysts said the BoE risked adding to the financial pain.

“We think that they are effectively cracking a supply side nut with a demand side hammer,” Richard McGuire, head of rates strategy at Rabobank, said.

Thursday’s move followed a rate hike in December, marking the first back-to-back increases in Bank Rate since 2004.

Suren Thiru, head of economics at the British Chambers of Commerce, said that, plus the four MPC members wanting a bigger increase, meant many would think the BoE was making “a leap towards a sustained period of significant monetary tightening.”

After the BoE’s announcement, investors priced in the Bank Rate hitting 1.5 per cent by year end.

“It would not be surprising if we see a further increase but please don’t get carried away,” Mr. Bailey said.

The BoE said consumer price inflation – which was 5.4 per cent in December – should peak at around 7.25 per cent in April, which would be the highest rate since the recession-ravaged early 1990s and miles off its 2-per-cent target.

While the European Central Bank showed on Thursday it would keep pumping in stimulus even as inflation runs at a record high, the BoE flagged further “modest tightening” even though growth will be hurt by global energy and goods price inflation.

High inflation meant post-tax income for working households would fall by 2 per cent this year and 0.5 per cent next year, while weakening demand would push unemployment up to 5 per cent in three years.

The BoE said it will start to unwind its £895-billion (US$1.2-trillion) quantitative-easing program by allowing the government bonds it holds to roll off its balance sheet as they mature. It will sell its much smaller stock of corporate bonds.

Price pressures look set to persist for much longer than forecast in November by the BoE, which tripled its forecast for wage growth this year to 3.75 per cent.

Inflation in a year’s time is now seen above 5 per cent based on the market outlook for interest rates.

But in a sign the BoE thinks investors have priced in too many rate hikes, it predicted inflation in three years would be below target at around 1.6 per cent.

Mr. Bailey, his deputies Ben Broadbent and Jon Cunliffe, chief economist Huw Pill and external MPC member Silvana Tenreyro all voted for a 25 basis-point rate hike.

The BoE said they recognized the risks of strong price pressures but also the potential for inflation to fall faster if global energy and goods costs ease as markets expect. They warned a larger rate hike could have an “outsized impact” on expectations for borrowing costs.

Deputy Governor Dave Ramsden and external members Michael Saunders, Jonathan Haskel and Catherine Mann voted for a half-percentage-point rate rise to reduce the risk that recent pay growth and inflation expectations became more firmly embedded.

The BoE said the unwinding of its asset purchases would start next month when a British government bond held by the central bank matures. The £27.9-billion of proceeds will not be reinvested, the BoE said – and nor will future gilt redemptions, worth around £70-billion over 2022 and 2023.

The BoE will consider actively selling gilts once the Bank Rate hits 1 per cent.

It said it plans to reduce its £20-billion of corporate bond holdings to zero no sooner than end-2023, by not reinvesting maturing bonds and a sales program.

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