Sterling gained almost a cent against the dollar as traders celebrated a surprising hawkish move which saw three of the eight economists on the Bank of England's rate-setting monetary policy committee (MPC) vote for an interest rate hike to combat rising inflation.
The pound, which had fallen as low as $1.2694 in morning trading, leapt as high as $1.2795 after Ian McCafferty and Michael Saunders joined Kristin Forbes in voting for a quarter-point hike. That left a tight five-three split, including the governor Mark Carney, in favour of keeping bank rate, the Bank's key interest rate, at historical lows of 0.25 per cent.
The last time there were three dissenting votes was in May 2011, with Forbes previously the lone voice on the committee in favour of a hike since March.
Minutes released today from the MPC's meeting revealed the surge in consumer prices since its last meeting had “reduced the MPC's tolerance of above-target inflation”.
Geoffrey Yu, head of the UK investment office at UBS Wealth Management, said: “The five-three vote today is clearly one that markets were not positioned for and sterling's reaction reflects this. There is a clear emphasis on the risk of a sustained inflation overshoot and the Bank of England probably does not want to be seen as being dismissive of such concerns."
Although the Bank did not mention the shock General Election result explicitly, the MPC cited the 2.5 per cent decline in the value of sterling since its Inflation Report at the start of May as a key factor in that reduced tolerance.
That fall in the value of the pound was prompted by the shock loss of the parliamentary majority by the Conservative party, following a disastrous campaign by Prime Minister Theresa May. The MPC said the weaker pound would contribute further to inflation overshooting the Bank's two per cent target.
Inflation reached 2.9 per cent in May, above the Bank's forecasts. That leaves no room for further increases above the MPC's May forecast of a peak "a little below three per cent" by the end of the year.
Withdrawing “part of the stimulus” from the post-Brexit vote August rate cut “would help moderate the inflation overshoot”, the minutes said.
The MPC also noted slack in the labour market “appeared to have diminished”, indicating its members think there is little way to go before wage pressures start to pick up, boosting inflation further.
However, wage growth remained “subdued”, the minutes said.
The Bank has repeatedly said it will focus on domestically generated inflation before considering raising interest rates.
The Bank predicts inflation will slow back below its two per cent target once the effect of the post-Brexit fall in the value of sterling has passed through.
The resignation of former deputy governor Charlotte Hogg meant the MPC, which met yesterday, was only one vote short of a tie, which would have necessitated the governor, Mark Carney, casting a deciding vote.
The MPC also voted unanimously to retain the £435bn stock of British government gilts built up during quantitative easing, as well as £10bn of corporate bond purchases.