Even as the Omicron variant engulfs the United Kingdom and threatens to put the economy into reverse, the Bank of England is raising interest rates in an effort to combat rising prices.
The Monetary Policy Committee of the central bank announced Thursday that interest rates would be raised from the record low of 0.1 percent to 0.25 percent, the first such move by any major central bank since the outbreak of the pandemic.
Consumer price inflation in the United Kingdom jumped to 5.1 percent in November, the highest level in more than a decade, putting the economy at risk of stagflation, a toxic combination of slow growth and rising prices. According to a business activity estimate released Thursday, December is shaping up to be the weakest month for the economy since February.
The Bank of England predicted that prices would rise further. “Bank staff anticipates that inflation will remain around 5% for the majority of the winter period, peaking at around 6% in April 2022,” the central bank said in a statement on Thursday. Energy costs and wage increases would also play a significant role in driving inflation higher next year, according to the report.
Economists and investors anticipated that the Bank of England would raise interest rates in November to combat rising prices. However, the Fed surprised observers by remaining silent, making a December hike all but certain until recently, when Omicron began to spread rapidly.
Higher official interest rates can increase the cost of borrowing for businesses and households while also encouraging people to save more, reducing demand and inflation. They can, however, take some of the sting out of the economy.
With inflation running two and a half times above the central bank’s 2 percent target, price concerns have overshadowed concerns about the Omicron variant’s potential to harm the economy.
“While the Omicron variant is likely to weigh on near-term activity, its impact on medium-term inflationary pressures is unclear at this time,” the Bank of England said.
According to Holger Schmieding, an economist at Berenberg, the rate hikes could take up to a year and a half to have an effect on inflation. Any economic damage caused by Omicron will have faded by then.
“Delaying the hike in the face of increased uncertainty, as most pundits predicted, would have been understandable. However, it would not have made sense. Inflationary pressures in the United Kingdom are high and appear set to remain so, owing in part to severe labor shortages and the legacy of five years of underinvestment since the 2016 Brexit referendum,” he said in a research note.
Massive stimulus efforts were launched by the world’s most powerful central banks in response to the pandemic. However, their approaches are now diverging, with the US Federal Reserve indicating three rate hikes next year while the European Central Bank maintains a looser stance.
The European Central Bank held interest rates steady on Thursday while lowering its growth forecast for the eurozone economy in 2022. The central bank announced that its €1.85 trillion ($2.1 trillion) pandemic stimulus program would end in March 2022, but that it would increase bond purchases under a separate program.
According to Capital Economics, the ECB will reduce the amount of money it pumps into the economy from an average of €92 billion ($104 billion) per month this year to roughly half that amount in April 2022. Despite the ECB’s projections that inflation will average 3.2 percent next year, well above the bank’s 2 percent target, interest rate hikes are not on the horizon at the moment.
“Economic activity has moderated in the fourth quarter of the year, and this slower growth is likely to continue into the early part of next year,” ECB President Christine Lagarde told reporters.
The Federal Reserve of the United States announced on Wednesday that it will complete its stimulus program sooner than previously announced, and that its updated economic projections show multiple interest rate increases in 2022.
Fed Chair Jerome Powell acknowledged that there is a risk that pandemic-era inflation will last longer than expected.
“One of the reasons for our move today is to put us in a position,” Powell said, to deal with inflation.