By David Milliken and William Schomberg
LONDON (Reuters) - The Bank of England raised interest rates for the first time in more than 10 years on Thursday, but sterling slid after the central bank said it expected only "very gradual" further increases as Britain prepares to leave the European Union.
The BoE's nine rate-setters voted 7-2 to increase the Bank Rate to 0.50 percent from 0.25 percent, reversing an emergency cut made in August 2016 after the Brexit vote.
It was the first BoE hike since 2007, before the global financial crisis tipped Britain into a deep recession.
However, sterling fell by more than a cent against the dollar and government bond yields plunged as markets homed in on the BoE's cautious tone on its next moves.
The BoE did not repeat previous language about markets underestimating the extent of future rises.
Governor Mark Carney said that in "broad brush" terms, the BoE was on the same page as investors who expect two more 25 basis-point rate hikes before the end of 2020.
But he noted inflation was still on course to exceed the BoE's 2 percent target in three years' time, a possible warning to investors not to be too relaxed.
Britain's economy slowed sharply this year after the Brexit vote in 2016, raising questions about the wisdom of raising rates now among many economists. But Carney fears that leaving the EU will aggravate Britain's already weak productivity growth and make the economy more prone to inflation.
Carney said the Brexit talks were likely to be the biggest factor for the next BoE move on rates, either up or down.
"We're going to be in exceptional circumstances for a period of time, certainly until there's clear resolution of the future relationship (with the EU), and even then, maybe longer than that," Carney told reporters.
He also said the sheer novelty of a first rate hike created some uncertainty about its impact on the economy, but there was no reason to expect this to be larger than normal.
Thursday's move meant the BoE followed through on its signal in September that an increase was coming, going some way to help counteract Carney's reputation - in the words of one British lawmaker - of being an "unreliable boyfriend" who did not follow through on previous guidance about higher rates.
TIMING IT RIGHT?
The two Monetary Policy Committee members who voted to keep rates steady, deputy governors Jon Cunliffe and Dave Ramsden, said wage growth was too weak to justify a rate rise now.
But the BoE said all nine MPC members backed its previous guidance that any future increases in the Bank Rate would be "at a gradual pace and to a limited extent".
The BoE said debt servicing costs paid by British households and companies would remain "historically very low" despite Thursday's hike.
UK Finance, representing major lenders, said 3.7 million people with variable rate mortgages would pay an average of 13 pounds ($17) more a month for every 100,000 pounds of debt.
Economists polled by Reuters had overwhelmingly predicted a hike at November's meeting, although nearly three-quarters of them thought it was too soon to make such a move, given the deep uncertainties about Brexit and weak wage growth.
"In our view, it's a bit of a gamble to hike at a time when the economy is stuttering and nobody knows which way the Brexit dice are going to roll," Dean Turner, an economist at UBS Wealth Management, said.
Howard Archer of economics consultancy EY ITEM Club, predicted rates would rise again only in late 2018. Credit Suisse said the BoE message increased the importance of the next two months of Brexit talks for financial markets.
"Progress ... could drive bond yields higher and a rebound in sterling," Credit Suisse strategist Pierre Bose said.
BOE DILEMMA
Thursday's vote split reflects the dilemma facing the BoE.
On the one hand, Britain's economy has grown slowly this year as a jump in inflation caused by the slump in the value of the pound after the Brexit vote pinched spending by consumers. Also, companies are offering sub-inflation pay rises to staff.
The central bank said the decision to leave the EU was already having a "noticeable impact" on the economic outlook.
But the lowest unemployment rate since the 1970s and an expected improvement in lacklustre productivity growth suggested pay growth was about to rise, the BoE added.
The BoE said it expected inflation to peak at 3.2 percent in October. Inflation would only fall back to close to its 2 percent target if Bank Rate rose in line with the "gently rising" path implied in financial markets.
This would mean rates hit 1 percent by 2020, with a single quarter percentage-point rise likely next year, it said.
The BoE is following the path taken by other central banks.
The U.S. Federal Reserve has already raised rates from their post-crisis lows and the European Central Bank is signalling a shift away from its huge stimulus for the euro zone economy.
Carney said other central banks were not forcing the BoE's hand, though a stronger world economy did help Britain.
The BoE stuck with its forecasts that Britain's economy would grow by 1.6 percent next year and by 1.7 percent in 2019.
Before the financial crisis, Britain's economy typically grew by more than 2 percent a year.
($1 = 0.7626 pounds)
(Reporting by David Milliken; editing by Guy Faulconbridge, John Stonestreet and Emelia Sithole-Matarise)
Disclaimer: No Business Standard Journalist was involved in creation of this content
