Bank of England boss Mark Carney has braced borrowers for further and faster interest rate hikes after stronger-than-expected growth in the economy.
Policymakers on the Bank’s nine-strong Monetary Policy Committee (MPC) voted unanimously to leave rates unchanged at 0.5%.
But Mr Carney said rates would need to rise sooner and by more than expected at the time of the Bank’s last forecasts in November to get inflation back to target.
It leaves the door open to a potential rate hike as soon as May, with markets also now pencilling in more than three hikes within three years.
Mr Carney refused to be drawn on the exact timing of future hikes, but said they would need to rise “somewhat earlier and by a somewhat greater degree” than expected at the time of the Bank’s last quarterly forecasts in November.
He stressed rises would be limited and gradual, assuring borrowers the UK will not return to interest rate cycles “experienced in the past”, when historically there were two rises a quarter and borrowing costs stood at 5% on average.
“We are not talking about going back to those levels or that historic pace,” he said.
The report sent the pound surging more than 1% against the US dollar and euro on the Bank’s rate hike hints, while the FTSE 100 Index fell 1%.
It comes after financial markets suffered a brutal sell-off at the start of the week in response to fears that rising inflation could spark interest rate hikes across a number of economies.
Financial markets believe there is a 50/50 chance of rates being raised to 0.75% in May, when the Bank’s next set of forecasts are due, with at least two more by the end of 2020, taking the bank rate to 1.25%.
The Bank said the economy had performed better than expected and upped its growth forecasts to 1.8% in 2018, from 1.6% predicted in November.
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Average annual growth is set to ease back to 1.7% in 2019 – in line with its November forecast – and remain at 1.7% in 2020.
On the rosier economic outlook, Mr Carney said global growth has helped boost the UK – in particular overseas trade – with the world economy growing at its fastest pace for seven years.
The UK expanded by a surprisingly strong 0.5% at the end of 2017, up from 0.4% in the third quarter, although the Bank said data suggested growth would ease back to 0.4% in the first quarter of 2018.
There was little cheer for financially squeezed households as its quarterly report showed rising oil prices would keep inflation above 3% in the short-term and see it take longer to return to target.
The Bank also cautioned that Brexit remained the biggest threat to growth, while households continue to be squeezed by poor wage growth and falling inflation.
Mr Carney said Brexit would be key to the rates outlook: “This is a crucial year for the Brexit negotiations and we will all be better informed by this time next year about the future trading relationship with the EU and that will have an effect on businesses and households and the outlook for the economy, inflation and therefore the policy of the MPC.”
There were also signs of strain in the housing market, where prices have softened, and in retail spending, according to the Bank.
James Smith, an economist at ING, said: “We now expect the Bank of England to increase rates at the May meeting.
“And given the Bank’s suggestion that rates will need to rise by a ‘greater extent’, a second hike in November certainly can’t be ruled out.”
But concerns remained that rapid rises could damage the economy.
Suren Thiru, head of economics at the British Chambers of Commerce, said: “If UK economic conditions do become more sluggish, we would caution the MPC against raising interest rates in the near term to avoid weakening business and consumer confidence.”