The blue-chip FTSE 100 share index fell by 50 points after the Bank raised rates from 7.25 per cent to 7.5 per cent, but regained some of its losses later in the day to close down 37.6 points at 5860.8.
The pound shot up by almost 2 pfennigs immediately following the announcement, but slipped in late trading to finish the day at DM2.898, down 0.45 pfennigs.
Gilts were also hit, with the September long gilt falling 0.53 points to 109.38.
The Bank's move coincided with the publication of three separate studies suggesting the economy was continuing to slow.
City economists had been predicting the Bank's Monetary Policy Committee (MPC) - joined for the first time this month by John Vickers, the Bank's new chief economist - would leave interest rates unchanged for the seventh successive month. Most - but not all - City economists were critical of the surprise interest rate hike, saying it could lead to a "hard landing" for the economy.
The Bank justified its decision by evidence of a rise in the rate of private sector earnings as well as sterling's relative weakness in recent months. In a statement, the Bank said: "Inflationary pressures appear greater than in the May projection, and the need for a slowdown in domestic demand growth has become more pressing."
Simon Briscoe at Nikko Europe said: "The MPC confounded market opinion and logic by raising rates this month. It is a rate rise that the Bank could regret in the months ahead if the economy slows sharply."
Mr Briscoe's view was shared by Richard Taylor, deputy chief economist at Royal Bank of Scotland, who called the rise "unexpected and unnecessary". Mr Taylor said: "The risk of this strategy is that it may rekindle interest in sterling and bring further misery for the manufacturing industry."
Ciaran Barr, senior UK economist at Deutsche Bank, was among those in the City who approved. He said: "The justification for raising rates was a valid one." However, Mr Barr said MPC members could have done more to prepare the City for a possibility of a rate rise, perhaps by injecting a more "hawkish" tone into recent public speeches. "Taking the markets by surprise will have won the Bank few friends," he said.
The decision prompted angry reactions from UK manufacturers. The strong pound has tipped manufacturing into recession, and many economists believe yesterday's rate rise will prolong sterling's strength.
Ian Campbell, director general of the Institute of Export, said the rate rise was "a slap in the face for the UK's exporters".
Neither the detailed reasoning behind the Bank's decision nor the voting record of the nine MPC members will be known for another six weeks, when the minutes of the meeting are published. However, this did not stop intense market speculation about the identity of the "hawks" on the committee who voted for a rate rise.
The voting behaviour of John Vickers, who joined the MPC this week, prompted the most comment. Mr Vickers, a former Oxford University professor renowned more for his regulatory expertise than his views on monetary policy, is widely believed to have voted for a rise.
Economists at Nikko Europe said: "We would guess that new boy Vickers voted for a rise: as chief economist he probably has sympathies with the Bank's economists' concerns about earnings growth and sterling weakness."Speculation also focused on Professor Charles Goodhart, a former hawk who became a dove in April.
In evidence to the Treasury Select Committee last month, Professor Goodhart said he had switched sides because of weaker than expected earnings growth as well as the appreciation of the exchange rate earlier this year.
However, in recent months, the trends on both average earnings - one of the key indicators for the MPC - and exchange rates have been reversed, prompting speculation that Professor Goodhart could have once again sided with the hawks.
If both Mr Vickers and Professor Goodhart voted for a rate hike, and assuming the three MPC members who wanted a rate rise in April again sided with the hawks, the MPC would have voted five to four in favour of a rate rise.
Some economists speculated that the minutes of the meeting - due to be published on 15 July - could reveal that as many as eight of the nine MPC members voted for a rate rise.
One said: "Eddie George may not have been comfortable finding himself in the minority. If he switched to the hawks, the rest of Bank staff may have voted with him." In April, Mr George, Governor of the Bank of England, voted to keep rates on hold, as did David Clementi, deputy governor, Ian Plenderleith, executive director of the Bank, Professor Goodhart and Dr DeAnne Julius, former chief economist at British Airways.
Mervyn King, deputy Bank governor, Sir Alan Budd and Professor Willem Buiter voted to raise rates.
The Bank's decision coincided with the publication of the latest CBI distributive trades survey, the 3i "Enterprise Barometer"and May figures on new car registrations.
The CBI survey showed that although growth in annual retail sales volumes held up in May, the underlying trend in sales growth was still relatively weak. Sudhir Junankar, the CBI's associate director of economic analysis, said: "The survey suggests that retailers do not expect their prices to pick up any further, which is good news for the inflation outlook,"
The survey by 3i, the venture capital group, showed falling confidence in the independent business sector, with manufacturers more gloomy than providers of services.
May new car registrations rose by just 1.7 per cent. Total registrations for the year to date are 7 per cent up on last year.Reuse content