By David Milliken, Andy Bruce and Suban Abdulla
LONDON, Nov 5 (Reuters) - The Bank of England raised interest rates for the first time in over three years on Thursday and warned that at least one more increase
was likely if the US-Iran conflict continues, as it started on a path already begun by its main peers.
British inflation is likely to rise to around 5% in the middle of next year, the BoE said, more than double the central bank's target and a blow to Prime Minister Andy Burnham, who has sought to ease cost of living pressures.
The BoE found little evidence so far of faster inflation outside sectors directly hit by higher energy costs. However, policymakers said that the amount of inflation pressure coming down the road after months of high energy prices required a rate rise now, even though that will increase borrowing costs for businesses and many home owners.
"Today's increase should not be seen as the first in an inevitable long sequence of hikes. That is not inevitable. But unless the conflict in the Middle East is resolved, neither does it seem likely to be the last increase," Governor Andrew Bailey said in his opening remarks at a press conference.
Sterling strengthened against the US dollar after the decision. Two-year British government bond yields — which are sensitive to expectations of future rate moves — rose while yields fell elsewhere, as investors increased bets on a back-to-back rate hike next month.
"December's meeting now looks like a coin flip, with the path of oil and natural gas prices set to be the decisive factor," said Andrew Goodwin, chief UK economist at Oxford Economics.
MPC UNANIMOUS OVER RATE HIKE, DIVIDED ON SIZE
The central bank's Monetary Policy Committee voted 8-1 to raise rates to 4% from 3.75%, the first rise since August 2023. In contrast to expectations in a Reuters poll, the dissent came not from a policymaker seeking to keep rates on hold but one seeking a bigger hike.
Catherine Mann, who said last month that the BoE had been slow to reassure markets that it had a grip on inflation, voted for a half-point interest rate increase to 4.25%.
Until now, the BoE had not followed the US Federal Reserve, the European Central Bank and other central banks in raising rates in response to inflation pressures from the Iran war, arguing that the higher starting level of BoE rates made a hike less urgent.
Bailey said a big fall in oil prices over the last 48 hours — a move largely driven by the results of US midterm elections — was "encouraging news" but said previous falls in oil prices and of easing Middle East tensions had proven to be false dawns.
Moreover, he said a further rate hike was likely to be needed even if oil prices stayed at current levels as there was "already a significant amount of inflationary pressure in the pipeline".
British household energy bills are regulated under a formula which follows wholesale prices with around a three-month lag.
MPC DISAGREE ON LIKELY EXTENT OF FURTHER RATE RISES
In minutes of November's decision, Mann said she was concerned about "non-linear inflation risks" as consumer price inflation had risen to 3.5% in September, which she viewed as a potential trigger for a loss of confidence in the central bank.
Coming into Thursday's decision, both investors and financial markets had been near-certain there would be a rate rise this month. But financial markets also priced in three quarter-point rate rises for 2027, more than most economists think is likely.
Bailey said such differences reflected financial markets pricing in tail risks of a sharp further rise in energy prices, while economists' expectations were based on the single most likely path, of a smaller amount of further tightening.
Both Deputy Governor Clare Lombardelli and Chief Economist Huw Pill said a further rate hike was likely to be needed in the near term. External MPC member Megan Greene — who like Mann and Pill had voted for a rate hike in September — talked of a need for "additional hikes".
However, MPC members Swati Dhingra and Alan Taylor – who had previously been reluctant to raise rates – said they would need stronger evidence of second-round effects before backing more tightening.
BOE PREDICTS FASTER GROWTH, HIGHER INFLATION
In its central forecast for growth and inflation, the BoE revised up its expectations for growth this year and next to 1.6% and 1.3% respectively — notably stronger than the government's Office for Budget Responsibility predicted last week.
The upgrade follows strong official data this year, and the BoE attributed some of the strength to spending on artificial intelligence and a small, temporary boost from finance minister John Healey's annual budget last week.
However, after the effect of inflation and taxes, the average British household's income from work is set to fall both this year and next, the BoE said.
Under the BoE's central scenario, inflation does not return to its 2% target until the third quarter of 2028, six months later than the BoE predicted in July after a lull in the US-Iran conflict which had lowered energy costs.
The BoE now sees inflation peaking at 4.8% in the second quarter of next year, and said it would have been on course to top 5% without measures in Healey's budget.
In a more adverse scenario where oil prices peak near $130 a barrel, up from around $100 currently, inflation hits 6.2% in the third quarter of 2027 – just under half the rate it hit in 2022 after Russia's full-scale invasion of Ukraine.
(Reporting by David Milliken, Andy Bruce and Suban Abdulla; Additional reporting by Sarah Young, Sam Tabahriti, Yoruk Bahceli and William James; Editing by Catherine Evans and Susan Fenton)
