The Bank of England announced a rate hike despite ongoing uncertainty over the future of the U.K. economy.
The Monetary Policy Committee voted unanimously for an increase in rates from 0.5 to 0.75 percent on the back of a strong labor market and credit growth.
The central bank said in a statement that if its macroeconomic forecasts proved right, the BOE would probably have to increase rates further, albeit gradually. In its latest inflation report, released Thursday, forecasts show that consumer price rises will hit 2.2 percent in 2019 and 2.1 percent in 2020.
The change in interest rate will bring higher costs for those borrowing money, including mortgages. On the other hand, it will likely benefit savers.
Governor Mark Carney told reporters Thursday that economic growth rebounded in the second quarter, after a slight slowdown at the start of the year. Carney said the slower economic activity seen in the first quarter was caused by cold weather.
"The bigger picture, however, remains one of external cost-pressures easing, with the peak impact on inflation from the referendum-related fall in sterling now behind us, and domestic inflationary pressures continuing to build as slack is absorbed," Carney said.
The BOE moved the interest rate from 0.25 percent to the level of 0.5 percent last November — marking the first hike in more than 10 years. The decision reversed an earlier cut in August 2016 in the wake of the Brexit vote.
Brexit
The bank said in the statement that it recognizes "that the economic outlook could be influenced significantly by the response of households, businesses and financial markets to developments related to the process of EU withdrawal."
Brexit remains the biggest uncertainty lingering over the U.K. economy. Negotiating teams for both Britain and the European Union want to reach an agreement by October ahead of the U.K.'s departure date of March 29 next year. However, there are still significant divergences on the table, with policymakers also preparing for a no-deal scenario.
Speaking after the meeting, Carney said that Brexit negotiations "are entering a critical period." He added that the forecasts and decisions taken by the central bank are based on the assumption that there will be "a relatively smooth transition" out of the European Union.
In such an event, trade between the U.K. and Europe would become more expensive for businesses and would likely see goods take much longer to reach their destination. The London Stock Exchange said Thursday that it had put together a contingency plan for a no-deal eventuality. This would include building new entities in the EU.
Sterling
Sterling fell against the dollar as Carney addressed the press. The currency initially rose following the rate decision, but reversed those gains to trade at about $1.3020 at around 1:20 p.m. London time.
Traders were initially surprised by the unanimous vote, which was interpreted as quite hawkish. However during the press conference, Carney repeated that rates will be moving gradually. He said that monetary "policy needs to walk not run."
What next?
In the wake of Thursday's meeting, analysts have sounded more bullish on the future rate-hike path that the BOE might take.
"The minutes and inflation report lend some support to our view that interest rates will rise by more than markets currently expect over the next few years," Ruth Gregory, senior U.K. economist at Capital Economics, said in a note.
Kallum Pickering, senior economist at Berenberg, said that as long as the U.K. did not abruptly break-up from the European Union, the BOE is on track to deliver two rate increases per year.
"As long as the U.K. avoids a no-deal hard-Brexit, look for the BOE to pick up the pace of rate hikes to two per year in 2019 and 2020 with the next hike coming in May 2019 after Brexit in March 2019 — taking the bank rate to 1.75 percent by the last quarter of 2020," he said in an email.