Borrowing costs have gone up as the Bank of England warns that the UK is facing is longest recession since the 1920s.

The base rate of interest was raised as expected by 75 basis points to 3%, its largest single rate increase since Black Wednesday of 1992.  

Borrowers face the highest repayments since the global financial crisis in 2008 after the 7-2 decision by the Monetary Policy Committee (MPC). Two members of the committee voted to raise rates by less than 0.75% this time round, which suggested further hikes may not be so aggressive.

The increase followed a similar announcement by the US Federal Reserve last night. It will particularly concern 1.5 million mortgages holders whose fixed rates are due to end.

Investors had priced in the increase and the FTSE 100 closed 44.49 points higher at 7,188.63. Sterling was last trading down 1.83% on the dollar at $1.1183.

Bank of England governor Andrew Bailey predicted a two-year recession for the UK – the longest since records began in the 1920s – stretching beyond its previous forecast of 15 months.

Gross domestic product (GDP) will shrink for 18 consecutive months, beginning in the early stages of next year and lasting until the end of 2024. The cumulative slump will shave around 3% off output.

On Black Wednesday, 16 September 1992, the Bank rate shot up 5% over the course of a day in a failed attempt to keep the pound within the trading range of the European Exchange Rate Mechanism. It was cut back to 10% the next morning.

There are current suggestions that the interest rate could increase further if inflation does not come under control.

Karen Ward, a member of Chancellor Jeremy Hunt’s economic advisory council, predicted this morning that interest rates will reach 5% over the next few months. However, the Bank eased concerns by saying that it did not think the MPC would hike rates that high.

In its statement, the Bank said: “The majority of the committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than priced into financial markets.” 

Analysts took that as further confirmation that the Bank was easing back on more hawkish interpretations of monetary policy.

Even so, businesses were facing up to the prospect of higher borrowing charges at a time when other costs are still high, as well as a prolonged period of weak demand.

David Bharier, head of research at the British Chambers of Commerce, said:  “The decision to raise the base rate to 3% comes as no surprise following the market turmoil caused by September’s mini-budget. 

“But raising the interest rate is a very blunt instrument to control inflation that is largely the result of global factors, including soaring energy costs and supply chain disruption.   

“This is further bad news for businesses who find themselves trapped between rising costs of raw materials, energyand borrowing, and weakening consumer demand. 

“The Bank is now clearly indicating the UK economy is set for a prolonged recession. Our own research shows that business confidence has been falling at an alarming rate over recent months, driven by runaway inflation.”

Nicholas Hyett, Investment Analyst, Wealth Club, said: “Recent macroeconomic data suggests previous rate rises are starting to have an effect. House price growth has slowed and perhaps even started to reverse. Consumer lending more broadly is also falling as the general public look to nurse wallets and purses over what is set to be a difficult winter.

“It’s far too early to call time on rate rises, but at least the two giants of British economic policy, the Bank of England and HM Treasury, no longer look like they’re squaring up for a bare knuckle boxing match. A joined up effort should calm market nerves and could help mitigate the long term pain.”

Andrew Megson, CEO of My Pension Expert, said: “The past week has seen market turbulence calm somewhat, following the appointment of Rishi Sunak as Prime Minister. But the BoE’s decision to hike interest rates to 3% is a stark reminder that the UK’s economic health remains fragile. 

“For pension planners, this means prolonged uncertainty for their financial future. Almost two fifths (37%) of UK adults aged 50 and over believe that the cost of living has made retirement impossible for the foreseeable future.”

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