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The Bank of England (BoE) has raised its main policy interest rate, or the Bank Base Rate, from 1% to 1.25%, in line with consensus expectations.

The move, however, disappointed some investors who were hoping for a larger rise following the 0.75% increase in the US federal funds rate earlier in the week.

Three of the nine-member committee again voted for a larger 0.5% rise, but the majority felt the smaller increase was more appropriate. As a result, the pound has fallen again against the US dollar and against the euro. The pound is now trading at below $1.20.

In its statement, the BoE mentioned that recent growth data had been weaker than the committee had expected, as consumer confidence has fallen further along with business sentiment. The bank said that the labour market remains very tight, even if unemployment rose slightly in the three months to April.

Meanwhile, the Bank has continued to warn of higher inflation on a CPI (Consumer Prices Index) basis, raising its estimate for the peak from 10% to 11% for October. Inflation is then expected to fall back, although higher oil prices of late could mean it proves stickier. It is likely that the old measure of RPI (Retail Prices Index) will peak at around 13%.

Looking ahead, we expect the Bank to deliver a 0.25% hike in each meeting until February 2023, peaking at 2.25%. However, the risk is skewed towards even more rises, as signs of “second round” inflation pressures are becoming more evident, even if the BoE is not concerned by them yet.

Second round pressures can occur as higher wages drive inflation higher still, at risk of round after round of wage and price rises, as expectations of inflation become a self-fulfilling prophesy.

Money markets are expecting a more aggressive hiking path, with investors expecting the Base Rate to reach just over 3% over the same time horizon. If the BoE continues to hike more slowly than market expectations, then we are likely to see the pound weaken further against other major currencies.

The value of the pound sterling has a dramatic impact on the price of imported goods, especially oil, petrol and diesel priced in US dollars. In 2007 pre credit crunch the average closing price of the dollar to the pound was $2.00. The average closing price in 2022 so far is $1.30.

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