LONDON — The Bank of England raised interest rates by 50 basis points on Thursday, the greatest single increase since 1995, and forecasted the U.K.’s longest recession since the 2008 global financial crisis.
This is the first half-point increase since the bank became independent from the British government in 1997. The sixth straight increase brings borrowing costs to 1.75%.
The Monetary Policy Committee voted 8-1 in support of the historic rate hike, citing rising inflationary pressures in the United Kingdom and the rest of Europe since its May meeting.
As a result of this having a knock-on effect on retail energy costs, it will worsen the decline in real wages of UK families and boost UK CPI inflation in the near future.
In April, Britain’s energy regulator, Ofgem, upped the energy price ceiling by 54% to match rising worldwide costs. In October, the energy price cap is projected to increase by an even higher amount, with annual family energy bills expected to exceed £3,600 ($4,396)
The bank now anticipates that headline inflation would peak at 13.3% in October and remain elevated for the majority of 2023, before dropping to its objective of 2% in 2025.
The MPC underlined that domestic cost and price pressures remain elevated and that there is a danger that “longer period of externally generated price inflation will lead to more enduring domestic price and wage pressures.”
Analysts were interested in evaluating the bank’s rhetoric, notably its prior pledge to act “forcefully” on inflation, and the MPC maintained this language in its Thursday report.
“Inflation hits the least well-off hardest, but if we don’t act to prevent inflation becoming persistent, the consequences later will be worse, and that will require larger increases in interest rates.”
The bank plans to begin active government bond sales of roughly £10 billion ($12.1 billion) every quarter beginning in September, pending final approval from policymakers.
The bank gave a bleak forecast for economic development, stating that the most recent increase in gas prices has caused a “significant deterioration” in the outlook for activity in the United Kingdom and the rest of Europe.
The MPC now forecasts that the United Kingdom will enter a recession in the fourth quarter of 2022, and that the recession will persist for five quarters as real household post-tax income declines rapidly in 2022 and 2023 and consumption begins to drop.
“Growth thereafter is very weak by historic standards. The contraction in output and weak growth outlook beyond that predominantly reflect the significant adverse impact of the sharp rises in global energy and tradable goods prices on U.K. household real incomes,” the MPC said in its monetary policy report.
The estimate predicts a 2.1% decline in output from peak to trough, with the economy beginning to drop in the fourth quarter of 2022 and continuing to contract throughout 2023.
“The labour market has remained tight, with the unemployment rate at 3.8% in the three months to May and vacancies at historically high levels,” the MPC said. “As a result, and consistent with the latest Agents’ survey, underlying nominal wage growth is expected to be higher than in the May Report over the first half of the forecast period.”
Following the bank’s pronouncement, the pound fell over 0.5% against the dollar, trading at roughly $1.209, while the FTSE 100 index rose 0.5%.
Cost of living crisis
Andrew Bailey, governor of the Bank of England, stated during a news conference following the announcement that the impact of Russia’s war in Ukraine is now “by some way” the largest contributor to U.K. inflation.
“There is an economic cost to the war, but I have to be clear, it will not deflect us from setting monetary policy to bring inflation back to the 2% target,” he added.
After U.K. inflation hit a fresh 40-year high of 9.4% in June as food and energy prices continued to rise, exacerbating the country’s historic cost-of-living crisis, the markets had generally priced in a more aggressive approach at the August meeting.
Luke Bartholomew, a senior economist at Abrdn, stated that the bank’s projections demonstrate how tough the U.K.’s economic outlook is relative to other large nations.
“The Bank is simultaneously forecasting a long recession starting later this year and an even higher peak in inflation. This is a toxic economic combination, which would be difficult for the central bank to navigate at the best of times, let alone when it is increasingly being dragged into the political spotlight,” he said.
According to reports, Liz Truss, the favourite to win the Conservative Party leadership contest and succeed Boris Johnson as prime minister, is considering a review of the Bank of England’s inflation mandate and its degree of independence from the central government.
“With inflation now expected to stick around for longer, it is hard to see how the Bank can pivot towards supporting the economy any time sooner. As such, investors should expect further interest rate increases from here even as markets and the economy struggle,” Bartholomew added.