LONDON (Reuters) - The Bank of England raised interest rates for the first time in more than 10 years on Thursday but sterling fell sharply as the central bank said it expected only "very gradual" further increases over the next three years.
The BoE said its nine rate-setters voted 7-2 to increase its benchmark bank rate to 0.5 per cent from 0.25 per cent, reversing an emergency cut made in August 2016, shortly after Britons unexpectedly voted to leave the European Union.
It was the first time that the BoE increased borrowing costs since 2007, before the eruption of the global financial crisis that tipped Britain into its deepest recession in decades.
However, sterling tumbled by more than a cent against the US dollar and government bond yields plunged as markets homed in on the BoE's cautious approach to future rate rises. The BoE did not repeat previous language about markets underestimating the extent of future rises.
BoE Governor Mark Carney said in "broad brush" terms, the central bank was on the same page as investors.
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.
The outcome of Brexit talks was likely to be the biggest factor driving whether the BoE would raise interest rates again, or cut them, Carney said.
"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 said in a news conference following the decision.
He repeated a warning about the "speed limit" on how fast the economy can grow without pushing up inflation after years of dire productivity growth.
The two Monetary Policy Committee members who voted to keep rates steady, deputy governors Jon Cunliffe and Dave Ramsden, shared the widespread view among economists outside the BoE that wage growth was too weak to justify a rate rise now.
"The jury is still out as to whether (today's decision) is the right one. Looking at the Bank's motivations, we don't necessarily agree that it is," said Dean Turner, an economist at UBS Wealth Management.
"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." But despite the economy's sluggish performance this year, most MPC members, including Carney, decided the timing for a tightening move was right.
"The MPC now judges it appropriate to tighten modestly the stance of monetary policy in order to return inflation sustainably to target," the BoE said in a statement.
"All members agree that any future increases in Bank Rate will be at a gradual pace and to a limited extent," it said, repeating its previous signals on what is likely to happen to borrowing costs.
The BoE said debt servicing costs paid by British households and companies would remain "historically very low" despite Thursday's hike.
UK Finance, which represents Britain's biggest lenders, said 3.7 million people with variable rate mortgages faced paying on average an additional 13 pounds 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.
"Given all the uncertainties about the outlook, not least what happens as the UK leaves the EU, we can construct scenarios where the BoE is having to cut rates again, or rates rise by more than expected over the next 12-18 months," said David Owen, economist at Jefferies.
The split on the MPC reflects the dilemma facing the central bank.
On the one hand, Britain's economy has grown only 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 increases to their staff.
The central bank said the decision to leave the EU was already having a "noticeable impact" on the economic outlook.
But it downgraded its estimate of how fast the economy could grow without generating excess inflation, justifying its decision to raise rates.
Consumer price inflation hit a five-year high of 3 per cent in September - mostly due to the fall in the value of the pound - and the BoE said it expected it to peak at 3.2 per cent in October. 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 fall back to close to its 2 per cent target only if bank rate rose in line with the "gently rising" path implied in financial markets.
This would mean rates hit 1 per cent by 2020, with one increase of a quarter of a percentage point likely next year, according to detailed forecasts in the Inflation Report.
The BoE will be following the path taken by other central banks.
The US 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.
The BoE said it now expected Britain's economy would grow by 1.6 per cent next year and by 1.7 per cent in 2019, unchanged from its forecast made in August and in line with a new, slower, sustainable rate.
Before the financial crisis, Britain's economy typically grew by more than 2 per cent a year.