The Bank of England voted to raise its base rate to 2.25% from 1.75% on Thursday, lower than the 0.75 percentage point increase that had been expected by many traders.
Inflation in the U.K. dipped slightly in August at 9.9% year-on-year, however, it remained well above the bank’s 2% target.
Energy and food have seen the biggest price rises, but core inflation, which strips out those components, is still at 6.3% on an annual basis.
The Bank of England now expects inflation to peak at just under 11% in October, down from a previous forecast of 13%.
The smaller-than-expected hike came as the bank said it believed the U.K economy was already in a recession, as it forecast GDP would contract by 0.1% in the third quarter, down from a previous forecast of 0.4% growth. It would follow a 0.1% decline in the second quarter.
This is its seventh consecutive rise and takes U.K. interest rates to a level last seen in 2008.
In a release explaining its decision, the bank noted volatility in wholesale gas prices but said announcements of government caps on energy bills would limit further increases in consumer price index inflation. However, it said there had been more signs since August of “continuing strength in domestically generated inflation.”
“The labour market is tight and domestic cost and price pressures remain elevated. While the [energy bill subsidy] reduces inflation in the near term, it also means that household spending is likely to be less weak than projected in the August Report over the first two years of the forecast period.” Bank of England in its Statement.
Five members of its Monetary Policy Committee voted for the 0.5 percentage point rise, while three voted for a higher 0.75 percentage point increase that had been expected by many. One member voted for a 0.25 percentage point hike.
The bank’s decision comes against a backdrop of an increasingly weak British pound, recession forecasts, the European energy crisis and a program of new economic policies set to be introduced by new Prime Minister Liz Truss.
Sterling hit fresh multidecade lows against the dollar this week, trading below $1.14 through Wednesday and dipping below $1.13 early Thursday. It has fallen precipitously against the greenback this year and was last at this level in 1985.