The panel was split on how big a rate increase was needed to tame inflation, highlighting the challenge facing central bankers as they balance rising prices and risks to growth from the pandemic.

Four of the panel’s nine members wanted a bigger rise, to 0.75%, citing widening and more persistent price pressures than expected. The majority, including Gov. Andrew Bailey, voted for a quarter-point increase, saying it should be enough to bring inflation back to their 2% target in the next two to three years.

The BOE also said it would begin slowly reducing the size of its bond-buying program by no longer reinvesting the cash it receives from maturing bonds in its portfolio, the first time a major central bank has embarked on a sustained effort to shrink its balance sheet.

With economies now in recovery, concerns about inflation are coming to the fore. Central banks are weighing up how to withdraw emergency policies introduced at the start of the pandemic without dampening growth.

The Federal Reserve has signaled it is likely to raise interest rates a number of times this year, likely starting March. The European Central Bank has signaled it doesn’t expect to begin raising rates in 2022 at all, though investors are beginning to question that time scale given accelerating inflation in the eurozone.

The BOE’s committee signaled it expects further rate increases ahead, saying “some further modest tightening in monetary policy was likely to be appropriate in the coming months.”

“We have not raised interest rates today because the economy is roaring away,” Mr. Bailey said at a news conference. He said officials were pushed to act because spiraling energy costs and surging goods prices risk fueling broader inflationary pressures in the British economy.

“An increase in Bank Rate is necessary because it is unlikely that inflation will return to target without it,” he said, referring to the BOE’s benchmark rate.

The pound strengthened 0.3% against the euro and 0.2% against the dollar after the decision. U.K. government bonds of all maturities sold off, with the benchmark 10-year gilt yield rising to 1.366%, the highest level since November 2018. Shorter-dated bonds moved the most, with one- and two-year yields also climbing to multiyear highs.

The decision was more hawkish than investors had expected, according to Arun Sai, a multiasset strategist at Pictet Asset Management. “They hiked by 25 but they came pretty close to hiking by 50. We are still trying to work out what the motivation is for the BOE to be this hawkish.”

“This is going to hurt the consumer so you could have argued for them to be a little more patient. Especially when you’re having to deal with energy prices going through the roof, inflation beginning to bite, fiscal tightening with taxes going up—on top of that you now have mortgage rates going up.”

Market pricing of interest-rate expectations now projects a faster pace of rises, with the policy rate reaching 1% by May.

In December, the BOE became the first major central bank to tighten monetary policy since the start of the pandemic when it raised its interest rate from a record low of 0.1%.

Thursday’s widely expected move marked the first time the BOE has raised rates at consecutive meetings since 2004. That “suggests there is concern amongst policy makers about the possibility of inflation expectations becoming dis-anchored,” said

Paul Hollingsworth,

chief European economist at BNP Paribas Markets 360. “Once the inflation genie is out of the bottle it’s quite hard to rebottle it.”

Consumer prices in the U.K. rose by 5.4% in December, the fastest in three decades.

In its Monetary Policy Report, the BOE marked up its inflation forecasts for this year and next. It now expects inflation to peak at around 7.25% in April before falling back as global bottlenecks ease and goods prices drop, averaging 5.75% over 2022.

While assessing the impact of the Omicron variant of the coronavirus as “limited and short duration,” it also revised its growth forecasts for 2022 down to 3.75% from 5% due to the impact of higher global energy and goods prices on spending.

Bond markets are currently pricing in four to five rate increases this year, but economists expect the BOE to proceed more slowly.

The BOE’s benchmark rate is now a quarter of a percentage point below where it was in early 2020. In common with other major central banks, the BOE responded to the pandemic by cutting interest rates and expanding its quantitative-easing program, doubling its pile of government debt to 875 billion pounds, equivalent to $1.19 trillion, over the past two years.

The MPC had previously said it would begin reducing its balance sheet once its policy rate reached 0.5%.

Economists say the decision to cease reinvestments may temper the pace of future rate rises. “The BOE will want to see what the effects of that are going to be without being too gung-ho on interest rates,” said

Philip Shaw,

chief economist at Investec Securities.

No major central bank has attempted so-called quantitative tightening over a prolonged period. The MPC has said it would consider active sales of government bonds once its interest rate reaches 1%. It said Thursday it plans to unload its small, £20 billion corporate-bond portfolio more quickly, possibly as soon as the end of next year.

The Reserve Bank of Australia this week said it would end a bond-buying program that has anchored its response to the Covid-19 pandemic after inflation accelerated faster than expected and the job market tightened considerably.

—Anna Hirtenstein contributed to this article.

Write to Isabel Coles at isabel.coles@wsj.com and Jason Douglas at jason.douglas@wsj.com