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Biggest interest rate rise for 25 years could spell showdown at the Bank | Interest rates

A lightning strike from the Bank of England awaits. Having delayed its decision until after the period of national mourning for the death of the Queen, Threadneedle Street could this week launch the biggest rise in borrowing costs for at least 25 years.

Announcing its plans a day before Kwasi Kwarteng’s mini-budget on Friday, the central bank is widely expected to use a fast and forceful rate increase to show its commitment to tackling soaring borrowing costs – despite the gathering storm clouds for the British economy.

City economists reckon a 0.5 percentage point rise will be the bare minimum, up from the current level of 1.75%, in a seventh consecutive rate rise – the most aggressive tightening cycle since at least 1997 when Gordon Brown’s first act as chancellor handed the Bank independence to set borrowing costs.

A tougher 0.75-point rise could be deployed, however. Threadneedle Street will not want to be left drowning in the wake of the US Federal Reserve, with the US central bank set to raise rates sharply on Wednesday after figures last week showed a much stickier picture for inflation in the world’s largest economy.

On this side of the pond, inflation may have dipped in August from 10.1% in July but remains close to its highest level since 1982 at 9.9% – almost five times the Bank’s 2% target rate – amid rising prices for food and other basic essentials.

Official figures showed unemployment dropped to its lowest since 1974, while job vacancies remained high, giving the Bank some indication of strength in the economy despite the looming risks of recession. Annual wage growth before inflation is taken into account – a key metric watched by the Bank – rose, even as workers continue to feel the pinch as inflation accelerates at a faster rate.

Financial markets are pricing an almost 90% probability that the cost of borrowing will be increased by 0.75 points, an unprecedented increase in 25 years of Bank independence.

“The scale of the energy shock we’re seeing is really not comparable to anything we’ve seen, so for monetary policy to act in an unprecedented way makes sense,” said Modupe Adegbembo, an economist at Axa Investment Managers. “Given the market pricing for a 75-basis-point rise, to not deliver that could add to weakness in sterling.”

Over summer the pound has plumbed the lowest depths against the dollar in 40 years, reflecting investor unease over the UK’s worsening economic prospects. Like other big European currencies, sterling has come under pressure from a stronger dollar, as well as concern over sky-high inflation amid Russia’s war in Ukraine.

However, in the currency-market ugly contest, Britain is particularly exposed. Investors reckon Liz Truss ramping up public borrowing to fund her £150bn energy support package is not helping matters. Nor are threats made in the Conservative leadership campaign to curb the Bank’s independence.

Details of Truss’s support measures are expected to come the following day in the mini-budget. Most economists expect it will help reduce the peak for inflation and cut the severity of the looming recession by putting more money in households’ pockets.

For the Bank, however, it could mean further interest rate increases to mop up the inflationary spillover from stoking the consumer economy. Financial markets expect the base rate to soar above 4.5% by next summer.

All of this sets up a big clash between the government and the Bank’s governor, Andrew Bailey, who has been in Truss’s crosshairs for some time, with a review of the central bank’s mandate expected this autumn.

Bailey is unlikely to be sackable, given the jitters in financial markets about Truss meddling with the Bank’s governance at a time of soaring public borrowing. But by stomping on the brakes with higher interest rates, just as Truss is pushing to get the economy moving at all costs, a big battle at the Bank of England is all but guaranteed.

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