The Bank of England has raised interest rates to 4% as it warned that inflation could climb to about 5% by the middle of next year, delivering a fresh shock to households, companies and financial markets.

The Monetary Policy Committee voted by eight to one to increase Bank Rate by 0.25 percentage points. One member called for a larger rise to 4.25%, underscoring concern that higher energy costs and persistent wage pressures could keep inflation above target.

Inflation outlook deteriorates

The decision marks the first increase in Bank Rate in three years and comes after consumer-price inflation rose to 3.5% in September, up from 2.6% in June. The central bank said the recent surge in energy prices had materially worsened the outlook.

Brent crude and UK gas futures were substantially higher than at the time of the Bank’s previous forecast, with oil averaging $108 a barrel and gas 216 pence per therm over the 15 working days to 27 October. The increase threatens to feed through into transport, heating and production costs.

The Bank also highlighted labour-market pressures. Private-sector regular pay growth was running at 3% in August, while business and recruitment indicators pointed to wage growth of roughly 4%.

Businesses face higher borrowing costs

The rate rise will increase financing costs for companies with floating-rate debt and may make new investment more difficult. Smaller businesses, property developers and highly leveraged firms are likely to feel the impact most quickly as lenders reprice loans and credit conditions tighten.

Markets had largely anticipated the move, but investors were focused on the Bank’s guidance about whether further increases would follow. Sterling, gilt yields and rate-sensitive shares remained vulnerable to any indication that policymakers were preparing to keep policy restrictive for longer.

The decision also comes as the British economy faces a difficult combination of weak growth, pressure on household finances and elevated input costs. Higher borrowing costs may help restrain demand and inflation, but they also risk weighing on housing activity, consumer spending and business expansion.

Markets and households adjust

Mortgage borrowers coming off fixed-rate deals face higher refinancing costs, while renters may also experience pressure if landlords pass on increased financing expenses. Companies reliant on consumer spending could face a tougher trading environment as disposable incomes are squeezed.

The FTSE 100 closed at 10,782.66, down 0.43%, while the FTSE 250 fell 0.86% in trading reported alongside the decision. Investors will now assess incoming inflation, wage and growth data for signs of whether the Bank’s forecast is too cautious or too severe.

For businesses, the central issue is whether the rate increase succeeds in containing inflation without deepening the slowdown. The Bank’s projections suggest that the next phase of UK monetary policy will be shaped as much by energy markets and pay settlements as by domestic demand.