- Despite an economic outlook clouded by COVID-19 uncertainty and households facing cost of living challenges, a majority on the Monetary Policy Committee (MPC) voted to raise Bank Rate for the first time since 2017.
- The increase from 0.1% to 0.25% was modest and still left the policy rate below the pre-pandemic level. The direct economic impact should be small and made smaller still by the decline in the share of households with a mortgage and growth in the popularity of fixed-rate mortgages over the last few years.
- But being the first rate rise for so long means the MPC’s decision carries more weight than the small addition to the cost of borrowing implies. And the novelty for people unused to a world of rising interest rates means the impact of today’s decision on the appetite to save or spend is more uncertain.
- That uncertainty means the MPC may choose to hold fire on a further rate increase in its next meeting in February. But COVID-19 permitting, the EY ITEM Club expects another increase in Bank Rate to 0.5% in May, before the policy rate returns to its pre-pandemic level of 0.75% by the end of next year.
Martin Beck, senior economic advisor to the EY ITEM Club, says:
“The outcome of December’s Monetary Policy Committee (MPC) meeting had appeared to be on a knife-edge: the strength of recent labour market data pointed to a rate increase, but the uncertainty caused by the emergence of the Omicron variant supported a ‘wait-and-see’ approach. That the margin in favour of a rate increase was as comprehensive as 8-1, was surprising.
“This represents a significant change of approach from the MPC. Previously during the pandemic, the committee had talked about the importance of risk management.
“A 15bp rise in Bank Rate still leaves rates well below pre-pandemic levels, and the removal of emergency policy support does seem to be a key justification of the MPC’s actions. The EY ITEM Club expects the impact on the economy to be small, particularly given the decline in the share of households with a mortgage and growth in the popularity of fixed-rate mortgages over the last few years. That said, the fact that this is the first rise in a long time does give it a greater degree of psychological importance.
“The near-term outlook for interest rates will be heavily dependent on how the Omicron situation evolves. Despite the decision to raise Bank Rate, the MPC is clearly concerned and expects the new variant to weigh on activity in the near term. This probably means the committee will avoid another rate rise in February. But, if it’s proven that Omicron hasn’t had a material impact on growth, the EY ITEM Club expects another increase in Bank Rate to 0.5% in May, before the policy rate returns to its pre-pandemic level of 0.75% by the end of next year.”