By Geoffrey Smith
Investing.com -- The Bank of England raised its key Bank rate by 75 basis points to 3.0%, its highest in 14 years, and warned that the U.K. economy may shrink for the next year and a half as the regional energy crisis aggravates home-grown problems.
However, in announcing its regular quarterly update on the outlook for the economy, the Bank caveated its forecasts heavily. It said they were calculated on the basis of market conditions in the middle of October, a period of extreme - and as it turned out, short-lived - volatility in U.K. financial markets, caused by the fiscal plans of Prime Minister Liz Truss.
Market interest rates implied at the time that the BoE would have to raise its key rate to 5.25%, whereas the Bank's own previous forecasts had foreseen a much lower path for rates.
The pound weakened as the market took the Bank's lengthy caveat as a sign that it doesn't have the stomach to raise rates as aggressively as the Federal Reserve from now on, given the extreme outcomes implied by the forecast model.
The Bank stressed that a rate path peaking at 5.25% would drive inflation well below its target of 2% by the end of 2024, implying a considerable "overshoot" of monetary policy.
By 08:45 ET (12:45 GMT), the pound was down 1.8% against the dollar at $1.1184.
With the economy already facing what the BoE called a "very challenging outlook," two of the Bank's 9-strong Monetary Policy Committee already voted for a smaller increase in the Bank Rate on Thursday. One voted for a half point increase, and the other for an increase of only a quarter point.
While the market volatility embedded in the new forecasts has largely subsided, the Bank's latest forecasts are also hostage to considerable political uncertainty. New Prime Minister Rishi Sunak is set to unveil comprehensive new fiscal plans for the remainder of the current parliament on November 17, and is under pressure to find ways to fill a hole in public finances estimated by some at over 40 billion pounds. The BoE said it will take the plans into account when the MPC next meets in December.