The Bank of England has raised interest rates by 0.75 percentage points to 3 per cent in its most forceful act to tame inflation for 30 years but signalled that borrowing costs would not rise in the future by as much as markets expect.

The pound fell 2 per cent against the dollar, which had been buoyed by a contrasting message from the Federal Reserve that US interest rates would increase by more than Wall Street anticipates.

Warning that the outlook was “very challenging” and forecasting a long recession ahead, the UK central bank issued unusually strong guidance that interest rates would not need to rise much further to bring inflation back to its 2 per cent target.

“We can make no promises about future interest rates,” said BoE governor Andrew Bailey. “But based on where we stand today, we think [rates] will have to go up by less than currently priced into financial markets. That is important because, for instance, it means that the rates on new fixed-term mortgages should not need to rise as they have done.” 

He added that the BoE’s rate-setting Monetary Policy Committee would “not pursue an [interest rate] path that will drive inflation sustainably below target”.

The BoE’s move matched the Fed’s 0.75 percentage point rise on Wednesday and an identical increase by the European Central Bank last week. Raising rates to 3 per cent took the UK’s official interest rate to its highest level since late 2008. It is the largest increase since 1989, apart from a swiftly reversed rise on September 16 1992, known as Black Wednesday.

Seven of the nine MPC members voted for the three-quarter point rise, saying in the minutes that “a larger increase” at the meeting “would help to bring inflation back to the 2 per cent target sustainably in the medium term, and to reduce the risks of a more extended and costly tightening later”.

But their guidance and the economic forecasts published by the BoE suggested a dovish outlook for UK interest rates.

The BoE laid out two possible scenarios. In one, interest rates would rise to 5.25 per cent, leading to eight quarters of contraction — the longest recession since the second world war — and inflation falling to zero in three years’ time.

But in a strong signal that it believes it may have already done the bulk of the work needed to curb inflation, the central bank highlighted an alternative scenario in which rates do not rise any further from the current 3 per cent.

In this scenario, inflation is projected to peak at 10.9 per cent in the fourth quarter of 2022 before falling to 5.6 per cent at the end of 2023, 2.2 per cent at the end of 2024 and below its 2 per cent target in 2025.

However, even if interest rates stay on hold at 3 per cent, the BoE still forecast a recession for five quarters, based on higher energy prices and mortgage costs.

The BoE said the majority of the MPC believed that “further increases” might be required for inflation to return sustainably to target but stressed that recent market pricing for the peak in interest rates had been too high.

When the BoE closed its forecast in the run-up to the meeting investors had been betting that rates would top out at 5.25 per cent. Markets currently expect rates to peak at 4.65 per cent in September next year.

The BoE estimates that 2mn mortgages will reach the end of their fixed term by the end of next year, with those with an average-sized mortgage of £130,000 having to pay £3,000 more annually to service their debts.

In a further dovish signal, the Bank said its forecasts were based on government policy as of October 17. They therefore do not take account of Prime Minister Rishi Sunak’s plans, due to be announced later this month, to make £50bn of savings, which would put further downward pressure on inflation.

The MPC said it would “take account of any additional information in the government’s autumn statement at its December meeting and in its next forecast in February”.

Two members of the MPC dissented from the vote to increase interest rates by 0.75 percentage points. Swati Dhingra voted for a rise of 0.5 percentage point rise, while Silvana Tenreyro voted for a 0.25 percentage point increase.