“The labour market remains tight and there has been evidence of inflationary pressures in domestic prices and wages that could indicate greater persistence and thus justifies a further forceful monetary policy response,” the MPC said in its statement on Thursday.

“The majority of the Committee judges that, should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target.”

The MPC noted the “considerable uncertainties” around the outlook, but said it will “respond forcefully” if inflationary pressures begin to look more persistent.

Having hit a 41-year high in October, the annual rise in the U.K. consumer price index slowed to 10.7% in November, new figures revealed Wednesday. The Bank expects inflation to fall gradually over the first quarter of 2023 as earlier spikes in energy and other goods prices drop out of the annual comparisons.

The slowdown mirrored signs across other major economies such as the U.S. and Germany that inflation may have peaked, though it remains uncomfortably high and well above the Bank of England’s 2% target.

Impact of government measures

The MPC said the government’s Energy Price Guarantee scheme had limited the rise in the consumer price index, but added that the contribution of household energy bills to inflation had continued to increase.

Finance Minister Jeremy Hunt announced in his Autumn Statement last month an increase in the household energy bill cap to £3,000 per year from April 2023 until March 2024. Other short-term fiscal support measures were also announced, but a raft of tax rises and spending cuts are set to tighten fiscal policy from 2024-25 onwards.

“Overall, Bank staff estimate that these measures, combined with the impact of the EPG, will increase the level of GDP by 0.4% at a one-year horizon, leave it broadly unchanged at a two-year horizon, but reduce the level of GDP by 0.5% in three years’ time, relative to what was assumed in the November Report,” the MPC said.

“The overall impact on the CPI inflation projection at all of these horizons is estimated to be small.”

In a statement Thursday following the Bank’s decision, Hunt said the government would continue to work “in lockstep with the Bank of England as they take action to return inflation to target.”

“The sooner we grip inflation the better. Any action which risks permanently embedding high prices into our economy will only prolong the pain for everyone, stunting any prospect of economic recovery,” he said.

A ‘more cautious path’

The Bank now expects U.K. GDP to contract by 0.1% in the fourth quarter of 2022, 0.2 percentage points stronger than in its November Report.

The MPC is trying to drag inflation back toward its target while also remaining sensitive to a weakening economy beset by several unique domestic pressures as well as global headwinds.

“The Bank finds itself in an increasingly tough spot as the emerging recession and financial stability concerns are balanced against ongoing wage pressures which risk embedding inflation. This is reflected in today’s wide range of voting decisions,” said Hussain Mehdi, macro and investment strategist at HSBC Asset Management.

“A downshift to 0.5% is sensible and we think the MPC will tread a more cautious path in 2023 as it assesses the impact of previous tightening on a weakening economy.”

This was borne out in the latest U.K. labor market data, published earlier this week, which showed an uptick in both unemployment and wage growth, while economic inactivity and long-term illness rates also remain historically high.

The MPC said that while labor demand has begun to ease, the labor market remains tight. The unemployment rate rose slightly to 3.7% in the three months to October. Wage pressures are a key focal point as policymakers assess the inflation outlook.

“Vacancies have fallen back, but the vacancies-to-unemployment ratio remains at a very elevated level. Annual growth of private sector regular pay picked up further in the three months to October, to 6.9%, 0.5 percentage points stronger than the expectation at the time of the November Report,” it said.

The Bank also maintained its quantitative tightening targets, which include plans to reduce its balance sheet by £80 billion ($99 billion) over a 12-month horizon through £40 billion of active asset sales and ending reinvestments of maturing bonds.