Bank of England raises rates to 1% despite looming recession risk

By William Schomberg and David Milliken

LONDON, May 5 (Reuters) - The Bank of England raised interest rates to their highest since 2009 at 1% on Thursday to counter inflation now heading above 10%, even as it sent a warning that Britain risks falling into recession.

The BoE's nine rate-setters voted 6-3 for the quarter-point rise from 0.75%. But Catherine Mann, Jonathan Haskel and Michael Saunders called for a bigger increase to 1.25% to stamp out the risk of the inflation surge getting embedded in the economy.

Economists polled by Reuters had forecast a more dovish 8-1 vote to raise rates to 1%, with one policymaker opposing a hike.

Central banks around the world are scrambling to cope with the surge in inflation that they once described as transitory when it began with the reopening of the global economy, before Russia's invasion of Ukraine sent energy prices spiralling.

The BoE said it was also worried about the impact of China's COVID-19 lockdown policies which threaten to hit supply chains again and add to the inflation pressure.

On Wednesday, the U.S. Federal Reserve raised rates by half a percentage point to a range of 0.75-1.0%, its biggest increase since 2000, and Fed chair Jay Powell said further 50 basis-point hikes were on the table for the next two meetings.

The BoE's move represented its fourth consecutive rate hike since December - the fastest increase in borrowing costs in 25 years - and it hardened its message about further increases, despite its worries about a sharp economic slowdown.

The BoE said most policymakers believed "some degree of further tightening in monetary policy may still be appropriate in the coming months".

It dropped the word "modest" to describe the scale of rate hikes ahead.

A split emerged in the Monetary Policy Committee with two members saying the guidance was too strong, given the risks to growth.

British consumer price inflation hit a 30-year high of 7% in March, more than triple the BoE's 2% target, and the central bank revised up its forecasts for price growth to show it peaking above 10% in the last three months of this year.

It had previously said it expected inflation to peak at about 8% in April.

The BoE said inflation in Britain would peak later than in other big advanced economies due to Britain's cap on household energy tariffs, which saw tariffs jump 54% in April and which the BoE thinks will rise a further 40% in October.

Real post-tax household disposable income - a measure of living standards - is forecast to fall 1.75% this year, the biggest calendar-year drop since 2011 and the second-biggest since the BoE's records began in the 1960s.

The BoE kept its forecast for economic growth this year at 3.75%, but slashed its forecast for 2023 to show a contraction of 0.25% from a previous estimate of 1.25% growth. It cut its growth projection for 2024 to 0.25% from a previous 1.0%.

While growth in the first quarter of this year has been stronger than the BoE predicted, it expects the economy to stagnate in the second quarter, due to an extra public holiday and reduced COVID testing, and a nearly 1% fall in GDP in the final quarter after the next increase in energy prices kicks in.

Those forecasts were based on bets in financial markets that the BoE would increase interest rates to about 2.5% by the middle of next year and the central bank signalled that was probably too much.

It said it expected inflation would fall to 1.3% in three years' time, the biggest undershoot relative to its 2% target since the 2008-09 global financial crisis, after unemployment rises and the cost-of-living squeeze hits the economy.

The BoE also said it would work on a plan for starting the sale of government bonds that it has bought since the global financial crisis a decade ago, which currently stand at just under 850 billion pounds.

BoE staff would update the MPC on the plan at its August meeting which would "allow the Committee to make a decision at a subsequent meeting on whether to commence sales".