UK Edition
Homeowners are facing three more years of mortgage pain after Andrew Bailey warned that price rises were “much more persistent” than the Bank of England predicted.
The Governor of the Bank said decisive action was needed to keep a lid on inflation as policymakers surprised economists with a 0.5-point increase in interest rates to 5pc. Mr Bailey said: “The economy is doing better than expected, but inflation is still too high and we’ve got to deal with it.”
The decision, backed by seven members of the Bank’s nine-strong Monetary Policy Committee (MPC), came as Threadneedle Street warned that markets are betting on average interest rates of 5.5pc over the next three years – a level that will add thousands of pounds to families’ bills.
Niesr, an economic think tank, said the crisis will wipe out the savings of 1.2m families this year and leave 7.8m in total with no financial safety net.
Sterling initially rose on the interest rate decision, climbing 0.4pc against the dollar to more than $1.28. However, it dropped later in the day to trade down at $1.27.
Government borrowing costs were little changed, with the yield on a two-year gilt up 0.03 points at 5.08pc.
The thirteenth consecutive increase takes interest rates to their highest level since 2008, following a series of unexpectedly strong inflation figures that have triggered chaos in bond and mortgage markets.
Thursday’s rise will immediately increase mortgage bills for more than 600,000 borrowers on tracker rates, with an average cost of £285 a year according to the baking trade body UK Finance.
Investors increased bets that interest rates will hit 6pc by the end of this year following the interest rate announcement as Goldman Sachs said it now expected another 0.5 percentage point hike in August to try to ward off stubbornly high services inflation, which had helped to stoke wage demands. Another increase of this magnitude would take interest rates to their highest since the end of 2007.
So-called swap rates, which are used by high street lenders to price fixed-rate mortgage deals, also rose in the aftermath of the decision, suggesting that borrowing costs are likely to remain high as more people come to the end of their mortgage terms.
Mr Bailey said: “We know this is hard – many people with mortgages or loans will be understandably worried about what this means for them.
“But if we don’t raise rates now, it could be worse later. We are committed to returning inflation to the 2pc target and will make the decisions necessary to achieve that.”
Policymakers warned that soaring prices would continue to drive up pay in the near term. The Monetary Policy Committee (MPC) that sets interest rates warned that rapid price rises that had fed demands for pay increases “were likely to take longer to unwind than they had to emerge”.
Price rises as measured by the consumer prices index remained stuck at 8.7pc in the year to May, the same as the April reading.
The MPC warned inflation was proving to be more persistent “against the background of a tight labour market and continued resilience in demand”.
Retailers and workers are trying to protect themselves from price rises by rebuilding profit margins or asking for higher pay, Mr Bailey said, warning that the jobs market remained tight.
He said: “Employment growth has been stronger than expected in May.”
The Governor added that food prices remained elevated, with the 18.3pc increase in overall food prices alone adding two percentage points to the headline inflation rate, he told the Chancellor in an open letter.
Only two members of the MPC, Swati Dhingra and outgoing member Silvana Tenreyro, voted to keep rates unchanged, warning that forward-looking indicators pointed to “material falls in future wage and price inflation”.
The Bank has come under increasing criticism for its failure to keep a lid on inflation. A series of senior economists have warned that a recession is now necessary to cool the economy.
Adam Posen, a former Bank policymaker, has warned that interest rates will need to rise to 6.5pc or higher in order to get inflation back to the Bank’s 2pc target.