The Bank of England has raised interest rates above the emergency level introduced straight after the financial crisis, despite mounting fears about the economic impact of Britain crashing out of the EU without a deal.
Signalling the gradual return of higher borrowing costs, Threadneedle Street raised interest rates to 0.75% from 0.5% – the level they were dropped to in March 2009 as the economy lurched through the last recession.
The Bank’s nine-member monetary policy committee voted unanimously for the increase, judging that the economy had bounced back from a soft patch earlier this year triggered by the freezing weather and heavy snowfall from the “beast from the east”.
While warning Brexit could blow the economy off course, the MPC said recent readings for economic growth “appear to confirm that the dip in output in the first quarter was temporary, with momentum recovering in the second quarter”.
The rate setters added that if the economy continued to recover as forecast, an “ongoing tightening of monetary policy” – meaning more interest rate rises – would be required to return inflation towards the Bank’s 2% target over the next few years.
Having made the call to move interest rates for only the third time in the past decade, the Bank’s latest decision comes amid growing fears over Brexit, with Theresa May facing parliamentary divisions over her plan.
Raising interest rates will mean higher borrowing costs on mortgages and loans for hard-pressed consumers and businesses as they adapt to Britain leaving the EU.
An extra 0.25% interest will add £12 a month to a £100,000 repayment mortgage and £25 on a £200,000 loan. However, nearly 70% of homebuyers have fixed-rate mortgages, so will be unaffected.
John McDonnell MP, the shadow chancellor, said the rate rise would be bad news for hard-pressed households: “Given recent revelations that households are spending more than they receive in income for the first time since 1988, today’s rise will be a blow to those facing high levels of personal debt.”
He added: “The Tories’ economic failure is making life difficult for families across the UK. They must change tack and end austerity once and for all.”
The British Chamber of Commerce said the increase was ill-judged and could hit confidence in the economy. Suren Thiru, head of economics at the BCC, said: “The decision to raise interest rates, while expected, looks ill-judged against a backdrop of a sluggish economy. While a quarter point rise may have a limited long-term financial impact on most businesses, it risks undermining confidence at a time of significant political and economic uncertainty.”
However, Andrew Sentance, senior economic adviser at accountants PwC and a former MPC rate-setter, said the rate hike “makes sense both from a short-term perspective and in terms of a sustainable long-term monetary strategy”.
Several economists had urged the Bank to keep rates on hold to help support jobs and growth amid the uncertainty.
Mark Carney, the Bank’s governor, had previously said it could use an emergency rate cut in the event of a no-deal Brexit. While Threadneedle Street has a mandate to steer inflation towards 2%, it can deviate to support the economy through difficult periods.
There has been some better news for the economy in recent months, with the summer heatwave and royal wedding giving the country a shot in the arm. Inflation has begun to fade from the highest level in five years, while unemployment also remains at the lowest level since the mid-1970s.
However, factory output has slowed amid softer global economic growth, as Donald Trump has slapped import tariffs on some of the US’s biggest trading partners, including the EU and China. Despite the low levels of unemployment in the UK, pay rises for British workers also remain elusive.
But in giving its verdict for higher rates, the MPC said it believed wages should begin to rise over the next three years, helped by the low levels of unemployment, while economic growth should average around 1.75% per year.
It said the pay rise for public sector workers, following the removal of the 1% cap by the government, had the possibility of spilling over to help workers in the private sector demand better wages.
Some economists have argued the unemployment rate of 4.2% masks the precarious nature of work for many people, which could hold back wage growth as workers’ bargaining power remains subdued. The most recent official figures show wage growth dropped to the lowest level in six months in the three months to May.
Having previously delayed raising interest rates in May, preferring to wait and see if the economy would recover as hoped, the decision to raise rates had been widely expected this time. However, the unanimous vote is likely to stoke speculation that further increases are around the corner.
Outlining its decision, the Bank said interest rates were unlikely to return to the levels seen before the financial crisis, when they were more commonly set above 5%.
It said weaker levels of productivity growth – a measure of economic output per hour of work – over the past decade meant there was an “equilibrium interest rate”, whereby it would neither be acting to stoke demand or depress economic growth, of between 2% and 3%.
Any future increases in the cost of borrowing are therefore likely to come at a “gradual pace and to a limited extent,” it added.