Britain’s central bank surprised markets on Thursday by increasing its main interest rate for the first time in three-and-a-half years to combat a surge in inflation, despite the economic uncertainty posed by the fast-spreading Omicron variant.
The Bank of England was the first major central bank to raise interest rates as inflation climbed to the highest level in a decade and the bank said it would not peak until April. Eight of the nine policymakers voted for a rate increase, compared with just two in November. After the announcement the pound jumped against the U.S. dollar, gaining more than 1 percent.
“There was some value in waiting for further information on the degree to which Omicron was likely to escape the protection of current vaccines and on the initial economic effects of this new wave,” policymakers said, according to the minutes of the central bank’s meeting. “There was, however, also a strong case for tightening monetary policy now” because of the strength on inflationary pressures in the economy.
Britain set a record on Wednesday for the reported number of coronavirus cases — 78,610 — and England’s chief medical official warned more records would be broken. The government has resisted putting major restrictions on businesses and social life, focusing instead on speeding up the rollout of booster vaccines and urging people to work from home. But now, Christmas parties and other get-togethers are being voluntarily canceled in droves, gyms are asking for more government support and people are retreating back into their homes.
For the Bank of England, the virus surge had threatened to delay policymakers’ efforts to get interest rates off the ground, especially if they judged that the new variant posed a serious risk to the economy. In their statement, they highlighted the uncertainty but said that in some scenarios, the spread of the new variant could worsen inflation.
“This is a surprising decision,” said Krishna Guha, a central bank analyst at Evercore ISI, because of the heightened uncertainty relating to Omicron. “But it reflects warning signs from the labor market and inflation expectations that there is a clear and present danger that excess inflation could become entrenched in the U.K.”
The Bank of England announced the rate increase the day after its enormous bond-buying program was set to be completed, bringing the total stock of government and corporate bonds it holds to £895 billion.
The Bank of England is far from alone in trying to deal with historically high levels of inflation. In the United States, prices are increasing at the fastest pace in nearly 40 years.
On Wednesday, the Federal Reserve said it would cut down its bond-buying program by more than it had previously announced, while policymakers signaled that interest rates could rise three times next year. Inflation in the eurozone is the highest its ever been since the creation of the common currency. On Thursday, the European Central Bank said it would end its pandemic-era bond-buying program in March but expand an older, smaller stimulus program.
Paul Mortimer-Lee, the deputy director of the National Institute of Economic and Social Research in London, said he was worried that central banks were reacting to inflation too late.
“My worry is it’s too late, that this horse has departed the stable,” he said. In Britain and the United States, the central banks “wanted to believe inflation was transitory and they didn’t want to believe what was right in front of their noses, that it’s been spreading,’ he said. “Now they’ve kind of woke up and they’re in catch-up mode.”
In early November, Britain’s central bank caught financial markets off guard by not raising interest rates after policymakers had signaled that high inflation was becoming a concern. At the time, they said they would wait for more information on whether the end of the government-funded furlough program in September led to an increase in unemployment. But they added that a rate increase would be likely be necessary in the “coming months.”
So far the data has shown an increase in payrolls, a continuing decline in the unemployment rate and record levels of job vacancies. The labor market has responded as policymakers hoped, but inflation has sped away from their expectations, increasing the pressure to raise rates.
The annual inflation rate rose to 5.1 percent last month, the highest since September 2011, the Office for National Statistics said on Wednesday. Last month, the central bank forecast that inflation would reach 4.5 percent by November and not peak at 5 percent until April. On Thursday, the bank updated its projections. Inflation would stay at about 5 percent through most of the winter and peak at around 6 percent in April. The central bank targets a 2 percent inflation rate.
“You’ve got these awful numbers,” Mr. Mortimer-Lee said of the inflation forecasts, “and the heaviest period of the year for wage bargaining is the first quarter.” There is already evidence that unions are demanding higher wage settlements in response to the decade-high level of inflation.
“These sorts of numbers are really what can unanchor inflation expectations,” he added. “And while the bank knows it can’t do anything about this first wave of prices, it’s got to try and stop it cascading into second and third rounds,” such as unsustainable higher wages.
For now, the inflation risk has outweighed growth concerns as the end of Britain’s economic recovery is delayed. On Thursday, the central bank also cut its growth forecasts for the fourth quarter by half a percent. At the end of this year, the economy would still be 1.5 percent smaller than its prepandemic size. The government’s latest measures and voluntary social distancing would weigh on the economy in the first quarter of next year, the bank predicted.
“The experience since March 2020 suggests that successive waves of Covid appear to have had less impact on G.D.P.,” the minutes said. “Although there is uncertainty around the extent to which that will prove to be the case on this occasion.”
Before the spread of Omicron, the British economy was already losing some momentum as supply chain disruptions and product and labor shortages hamstrung companies. In October, gross domestic product increased just 0.1 percent from the previous month, with the accommodation and food industries declining. That looks set to worsen as the hospitality industry risks losing out on revenue during the crucial festive period.
“The new Omicron variant is a significant new source of uncertainty for the outlook,” Ambrose Crofton, a strategist at JPMorgan Asset Management, said in a note to clients. But if spending is diverted to more goods instead of services, or simply delayed, allowing the economy to regain its lost output at a later point, “then further rate hikes will follow,” he added.
Jeanna Smialek contributed reporting.