This is the 10th time in a row that the central bank has increased rates as it tackles record high inflation, making borrowing costs higher despite the risk of a looming recession.
The Monetary Policy Committee voted by a majority of 7–2 to increase Bank Rate by 0.5 percentage points, to 4%.
Two members, Swati Dhingra and Silvana Tenreyro, preferred to maintain Bank Rate at 3.5% - they had both voted for no change in December as well.
The Bank of England said inflation 'likely to have peaked', according to its Monetary Policy Summary for February
It said: "Global consumer price inflation remains high, although it is likely to have peaked across many advanced economies, including in the United Kingdom.
"Wholesale gas prices have fallen recently and global supply chain disruption appears to have eased amid a slowing in global demand.
"Many central banks have continued to tighten monetary policy, although market pricing indicates reductions in policy rates further ahead."
Threadneedle Street is trying to walk a very fine line. It does not want to push the UK into a recession by raising borrowing costs but its mandate is to keep inflation at around 2%.
The rate of inflation eased to 10.5% but remains close to a 40-year high as UK households continue to be squeezed by the cost of living crisis. Businesses are being crushed by struggling to find affordable credit.
While inflation is now falling thanks to softening energy prices, there are fears that persistent strong wage growth could still keep it well above the BoE’s 2% target.
Mortgage shock for millions
This interest rate rise will push up borrowing costs for the approximately 2.2 million people on a variable rate mortgage. More than a million households must renew their fixed-rate deals this year, and already face a jump in repayments.
Ipek Ozkardeskaya, senior analyst at Swissquote Bank, said: "In one hand, the double-digit inflation continues taking a toll on the UK economy and on people’s lives. According to the latest data, food inflation in Britain hit the eye-watering level of 16.7% in the 4 weeks to January 22. On the other hand, the rising rates take a toll on the British housing market."
William Marsters, senior UK sales trader at investment platform Saxo, added: This rise in interest rates has hit borrowers hard and those with large mortgages or credit card loans in particular will continue to feel the squeeze with the cost of living already tightening any kind of consumer purchasing power. Some homeowners have even decided to roll the dice and apply floating rates to their mortgages, taking the pain now in the hope that inflation will soon reduce and rates turn lower again later in the year.
T"he UK is still likely to enter a recession in the coming months, something the BoE would have had to factor into their decision, and in the long term this should see consumer prices pressured, though many businesses will be negatively affected with costs already proving difficult to manage.”
More than 1.4 million UK households are due to renew their fixed-rate mortgages in 2023, the Office for National Statistics said in January.
— Bank of England (@bankofengland) February 2, 2023
Adrian Anderson, director of property finance specialists Anderson Harris, said: “It's almost impossible to remember that the Bank of England base rate stood at just 0.1% in December 2021. Some 1.8 million mortgage holders will see their fixed rate deal finish in 2023 and are yet to feel the impact of rising interest rates. These homeowners, along with the estimated 2 million on variable rate deals are likely to have a mortgage shock and face a significant increase in their payments at the same time as most of their other outgoings have increased markedly.
“Only a very small number of mortgage holders are currently behind on their mortgage payments but there is risk this number could rise as homeowners move onto much higher mortgage rates. Homeowners are in a very different place to the 'old normal' of the last 14 years.”
The Bank has been raising rates successively for more than a year. In December 2021 the base rate stood at just 0.1% as policymakers tried to encourage consumer spending after COVID slowed the economy.
Interest rates could peak at 4.5% or 4.25% next month, before coming back down.
The US Federal Reserve opted to raise rates by 0.25 percentage points on Wednesday to 4.5% to 4.75%, although Fed chairman Jerome Powell said the bank had “more work to do” to bring inflation back to its 2% target.
The European Central Bank is expected to raise its deposit rate by 50 basis points from 2% to 2.5%.
Watch: How does inflation affect interest rates?