BOE Governor Andrew Bailey warned that the bank was walking a “narrow path” between growth and inflation.
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LONDON — The Bank of England on Thursday raised interest rates by 50 basis points, its biggest single increase since 1995, and forecast the UK’s longest recession since the global financial crisis.
The sixth consecutive increase raises borrowing costs to 1.75% and marks the first half-point increase since the Bank became independent from the British government in 1997.
The Monetary Policy Committee voted 8-1 in favor of the historic half-point increase and cited rising inflationary pressures in the UK and the rest of Europe since its previous meeting in May.
“This largely reflects a near doubling of wholesale gas prices since May due to Russia’s cap on gas supplies to Europe and the risk of further cuts,” the MPC said in its accompanying statement.
“As this affects retail energy prices, this will exacerbate the fall in real UK household incomes and further increase UK CPI inflation in the near term.”
Britain’s energy regulator Ofgem has increased the energy price cap by 54% since April to accommodate rising global costs, but it is expected to rise more in October, with annual household energy bills expected to exceed £3,600 ($4,396).
The Bank now expects headline inflation to peak at 13.3% in October and remain high through most of 2023 before falling to its 2% target in 2025.
At a press conference after the announcement, Bank of England Governor Andrew Bailey said the shock from Russia’s war in Ukraine was now the biggest driver of UK inflation “by some way”.
“The war has an economic cost, but I must be clear, this will not distract us from setting monetary policy to bring inflation back to the 2% target,” he added.
The bank is simultaneously predicting a long recession starting later this year and an even higher peak in inflation. It’s a toxic economic mix that would be difficult for the central bank to navigate at the best of times, let alone when it is increasingly drawn into the political spotlight.
Luca Bartholomew
Senior Economist, Abrdn
Markets had appreciated a generally more hawkish approach at the August meeting after UK inflation hit a new 40-year high of 9.4% in June as food and energy prices continued to rise, deepening a historic spending crisis for life in the country.
Bailey promised last month that there would be no “ifs or buts” in the central bank’s commitment to return inflation to its 2% target.
Analysts were keen to gauge the bank’s language, particularly its previous commitment to act “forcefully” against inflation, and the MPC retained that language in Thursday’s report.
“I recognize the significant impact this will have and how difficult the cost of living challenge will continue to be for many people in the UK,” Bailey said.
“Inflation hits the poorest hardest, but if we don’t act to prevent inflation from persisting, the consequences later will be worse and that will require bigger increases in interest rates.”
The bank said it intended to start active sales of roughly £10 billion ($12.1 billion) worth of government bonds per quarter from September, subject to a final green light from policymakers.
A recession is coming
The bank published a dire outlook for economic growth, suggesting that the latest rise in gas prices had led to another “significant deterioration” in the outlook for business in the UK and the rest of Europe.
The MPC now forecasts that the UK will enter recession from the fourth quarter of 2022 and that the recession will last for five quarters as real after-tax household income falls sharply in 2022 and 2023 and consumption begins to shrinks.
“Growth after that has been very weak by historical standards. The contraction in output and the weak outlook for growth beyond this mainly reflects the significant adverse impact of the sharp rise in global energy and commodity prices on real UK household incomes,” the MPC said in its monetary policy report.
The forecast warns of a 2.1% drop in output, with the economy starting to contract in the fourth quarter of 2022 and contracting in 2023.
Luke Bartholomew, senior economist at Abrdn, said the bank’s forecasts clearly show how difficult the UK’s economic picture is compared to other major countries.
“The bank is simultaneously forecasting a long recession starting later this year and an even higher peak in inflation. It’s a toxic economic mix that would be difficult for the central bank to navigate at the best of times, let alone when it grows to be pulled into the political spotlight,” he said.
Liz Truss, the favorite to win the Conservative leadership race and succeed Boris Johnson as prime minister, is reportedly considering a review of the Bank of England’s inflation mandate and the extent of its independence from central government.
“With inflation now expected to persist for longer, it is hard to see how the Bank can move to support the economy any sooner.” As such, investors should expect further rate hikes from here, even as markets and the economy struggle,” Bartholomew added.
Sterling fell more than 0.5 percent against the dollar after the bank’s announcement, trading at around $1,209, while the FTSE 100 rose 0.5 percent.
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