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Pound Slides After Bank of England Signals Caution as It Raises Rates

LONDON—The Bank of England raised its key interest rate for the fourth time in as many meetings of its policy makers, but signaled that it is likely to move cautiously in coming months as worries grow over a slide into recession, triggering a sharp selloff in the pound.

As in the US, the UK has seen a surge in consumer prices since early 2021, driven by higher energy costs and supply-chain bottlenecks. In response, the UK’s central bank first raised its key interest rate in December, while the Federal Reserve announced its first move in March.

The BOE’s cautious tone prompted a selloff in the pound. The currency weakened nearly 2% against the dollar, falling the most in over 14 months and reaching the lowest level since July 2020.

In a statement Thursday, the BOE raised its key rate to 1% from 0.75%. That means the central bank has increased borrowing costs at four straight meetings of its Monetary Policy Committee, an unmatched sequence since the late 1990s.

Six MPC members voted for the rate rise to 1%, while three voted for a larger rise to 1.25%.

The central bank also said it has asked its staff to prepare a plan for selling some of the bonds it bought as part of its past stimulus programs. That plan is set to be outlined in August, but bond sales would start later.

However, the central bank indicated that it is likely to raise rates more slowly, if at all, in coming months, with the very high energy prices that have followed Russia’s invasion of Ukraine set to squeeze household spending power and weaken economic growth.

In its statement, the BOE said further rises in its key rate “may still be appropriate” in coming months, but added that two of its policy makers didn’t support that guidance and instead thought it likely the key rate would stay at 1% .

“There were a range of views about the need for, and extent of, any further tightening in policy in the coming months,” said Andrew Bailey, governor of the BOE, in a news conference.

That greater caution is a contrast with the Fed, which Wednesday approved a rare half-percentage-point interest-rate increase to a target range between 0.75% and 1%. Fed Chairman Jerome Powell said at a news conference that officials broadly agreed that additional half-point increases could be warranted in June and July given current economic conditions.

Mr. Bailey said one reason for that caution compared with the Fed is that while the US is “facing what looks like a demand shock, with a strong domestic labor market, strong domestic demand,” the rise in UK prices is mainly driven by developments overseas that are likely to chill demand.

There are already signs of a slowdown in consumer spending as larger shares of household income are eaten up by higher energy costs.

UK consumers were last month hit with a 54% increase in home energy prices. The BOE said it expects energy bills to rise by a further 40% when the ceiling on prices is reviewed again in October.

If that increase happens, the BOE expects the annual rate of inflation to average 10% over the final three months of the year, reaching highs not seen since 1982. Because the energy price rises caused by Russia’s invasion of Ukraine will only reach households in October , UK inflation is set to peak later than in other countries.

But as well as pushing inflation higher, that rise in home energy prices is expected by the BOE to weaken household spending further, leading to a decline in gross domestic product of around 1% in the final quarter of the year. The BOE said it expects real household disposable income after tax to fall 1.75% in 2022. That would be the largest fall since 2011, and the second-largest since the series began in 1964.

Stores are already seeing the squeeze on household incomes. Retail sales fell 1.4% in March, having declined 0.5% in February. Surveys have also recorded a large decline in consumer confidence, with one leading measure finding that households are more pessimistic about the economic outlook over the coming 12 months than they were during the 2008 global financial crisis.

The BOE doesn’t expect two straight quarters of economic contraction, a widely accepted definition of recession. Instead, it expects the economy to stagnate in 2023, with GDP declining 0.25%. The BOE had previously forecast growth of 1.25%.

The BOE pushed back against the expectations of participants in financial markets, who see the key interest rate rising to 2.5% by mid-2023. If that were to happen, the BOE said inflation would be well below its 2% target in three years’ time at 1.3%. Leaving rates at 1% would see inflation slightly above 2% in mid-2025, the BOE said, an indication that it sees more modest rate increases than financial markets have priced in.

Write to Paul Hannon at paul.hannon@wsj.com

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