Pound drops to $1.11 after Bank of England raises rates to tackle surging inflation

Governor Andrew Bailey says Britain facing longest recession for more than 100 years

In currency markets, the pound dropped to $1.1158, a fall of more than 2 per cent in one day. AFP

The pound has tumbled in trading after the Bank of England raised interest rates and said that the country was headed for a prolonged recession.

UK policymakers on Thursday raised the base rate by 0.75 per cent to 3 per cent, the largest single jump since 1989, in a bid to tame runaway inflation that has surged to its highest level in decades.

In currency markets, the pound dropped to $1.1158, a fall of more than 2 per cent in one day. Against the euro, it was down 1.25 per cent at 87.25 pence.

At a press conference following the rates decision, Bank of England Governor Andrew Bailey said that things would get worse for all Britons if the bank did not raise interest rates, which could hit mortgage-holders by £3,000 ($3,400) a year.

The bank also said that the UK could be on course for the longest recession since reliable records began in the 1920s.

“We do understand the difficulties of the situation we’re in and the difficulties mortgage-holders face,” Mr Bailey said.

“If we don’t take action to get inflation down, things will get worse.”

The Bank of England governor said there was “no easy outcome to this”.

For investors, the move shows how the bank needs to balance monetary policy in the face of rampant inflation and the prospect of an economic slowdown.

“The BOE hiked by 75 basis points but revised down its growth and inflation projections, sending a clear signal that the bank rate path expected by the markets ahead of the policy meeting is too high,” said Valentin Marinov, head of G-10 currency strategy at Credit Agricole SA.

“The outcome contrasts sharply with the hawkish message from [US Federal Reserve Chairman Jerome] Powell yesterday and could trigger a further drop of the pound-dollar rate spread.

“What we have announced today … should not lead to higher mortgage rates — I think there is a downside to mortgage rates in that sense.”

He added that the market expects mortgage rates to drop.

The latest decision pushes interest rates to their highest level since early December 2008 and will heap extra pressures on households.

It is the biggest single increase to the UK base rate since 1989, when the measure was still decided by the government.

Decision makers also said that more increases were likely to come, however they do not expect rates to rise as high as the 5.2 per cent that the market has forecast for the final quarter of next year.

“The majority of the committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in the bank rate may be required for a sustainable return of inflation to target, albeit to a peak lower than prices into financial markets,” the bank said on Thursday.

The bank also said there are still uncertainties, however, and if inflation looks to be more persistent than the current outlook, it will “respond forcefully”.

From its highest to lowest point, gross domestic product is expected to drop 2.9 per cent, the bank said, compared with 6.3 per cent during the financial crisis.

Meanwhile, unemployment is expected to peak at about 6.5 per cent, from 3.5 per cent today, slightly lower than in 2008.

There was better news in the bank’s inflation projection.

It had previously forecast inflation to peak at 13 per cent in the third quarter of this year, but with the government’s support of household energy bills, the forecast was slashed to 10.9 per cent.