The Bank of England is seen in London March 19, 2008. REUTERS/Luke MacGregor

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  • The BoE is expected to raise rates to 0.5% on February 3
  • UK inflation hit its highest level in almost 30 years in December
  • BoE concerned about impact of energy prices and wage pressure
  • Financial markets see BoE rates at 1.25% by November

LONDON, Jan 24 (Reuters) – Britain’s central bank plans to raise interest rates next week for the second time in less than two months, further reversing its stimulus measures against the COVID-19 pandemic, after the inflation has reached its highest level in nearly 30 years.

Inflation rose sharply in advanced economies, driven by higher energy prices and supply chain difficulties. But the Bank of England has moved faster than other major central banks on concerns that expensive energy and a tight labor market are seeing price pressures take root.

Most economists polled by Reuters last week expect the BoE to hike rates to 0.5% on Feb. 3 from 0.25%. On Monday, rate futures carried an 87% probability of such a move. Read more

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“They need to do something in the short term to boost their credibility, anchor inflation expectations and maybe also support the pound, to improve the outlook for inflation,” said Samuel Tombs, chief economist of the consulting firm Pantheon Macroeconomics.

The BoE has not raised rates at two consecutive meetings of the Monetary Policy Committee (MPC) since June 2004.

A hike would also put the 875 billion pounds ($1.18 trillion) of government bonds held by the BoE on a downward trajectory as it stops reinvesting maturing gilts.

Tombs advanced its forecast for a BoE rate hike by a month after data last week showed consumer price inflation hit 5.4% in December, its highest level. since March 1992.

Inflation – which has exceeded BoE forecasts for the past six months – is expected to peak at more than 6% in April when regulated household energy bills rise by around 50% after the recent spike in gas prices.

BoE Governor Andrew Bailey said last week that inflation was likely to be more persistent than the BoE had forecast in November due to tensions between Russia and Ukraine. Futures markets showed natural gas prices staying high for longer.

He added that companies were considering raising prices and wages this year in a way that would make inflation too slow to fall back to its 2% target. Read more

“The objective of monetary policy should now be to build on this ‘strong’ scenario for longer,” MPC external member Catherine Mann said on Friday. Read more

The other seven members of the MPC have not said anything publicly about the policy this year, and a rate hike in February is not final.

The BoE took markets on the wrong foot in November when it left rates unchanged, triggering the biggest weekly decline in bond prices since 2009. Its new chief economist, Huw Pill, later said that markets should not expect detailed guidance on political action.

NEW FORECASTS

The BoE will release new growth and inflation forecasts on Feb. 3, replacing the November ones that were quickly overtaken by higher-than-expected inflation and the Omicron variant.

Economists also want to know how far the BoE thinks rates could rise further, and whether it might need to take them above “neutral” at a tightening level.

In November, the BoE downplayed market expectations that rates could hit 1% this year. Now, markets expect rates to hit 0.75% – their pre-pandemic level – in May and 1.25% in November.

Britain’s surge in Omicron-linked COVID-19 cases – which were increasing when the BoE raised rates on Dec. 16 – is now less than half of the peak in early January.

Economists estimate that the financial damage was mostly confined to sectors such as hospitality, dragging output down about 0.5% in December and January.

Gross domestic product returned to pre-pandemic levels for the first time in November.

The labor market performed stronger than expected by the BoE, with unemployment close to pre-pandemic levels, although there are around 600,000 fewer people in employment, with some older workers dropping out of the population active.

This, combined with record vacancies, is fueling BoE concerns about labor market pressures. Mann pointed to a potential “regime shift” from the 2010s, when wage growth was weak even when inflation soared above 5% due to a spike in oil prices in 2011.

“While the recovery hasn’t been particularly bright, it looks like we’re starting to experience supply-side constraints a little earlier than other countries,” Pantheon’s Tombs said.

Brexit friction and weak business investment since the 2016 referendum are likely to blame, he added, and he doubts workers’ bargaining power has strengthened much.

($1 = 0.7412 pounds)

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Reporting by David Milliken; Editing by Catherine Evans

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