The UK economy will shrink as rising energy bills push inflation to more than 10 per cent, the Bank of England has warned as it raises interest rates to a 13-year high.
Inflation is expected to double in October, when households will be affected by another 40% increase in energy bills, the Bank’s Monetary Policy Committee (MPC) said on Thursday.
The MPC raised interest rates by 0.25% to 1% in a bid to curb rampant inflation, while predicting that the UK economy will be on the brink of recession next year.
Average gas and electricity bills are expected to reach £ 2,800 when Ofgem raises its price cap to reflect rising wholesale energy costs, exacerbated by the war in Ukraine. Prices for food and other basic goods and services are also expected to continue to rise.
The MPC warned that while wage growth will be stronger than previously forecast, household disposable incomes will continue to fall.
A further decline in consumer spending is expected to shrink the economy in the last quarter of 2022.
Revenue cuts are expected to peak later this year before easing in 2023, but costs will continue to be limited by persistently high energy prices, according to an MPC report.
While the UK will technically avoid a recession – defined as two-quarters of negative growth – energy prices are expected to remain higher, holding back consumer spending and straining the economy as a whole.
The bank now forecasts zero growth in 2023, followed by 0.2% in 2024 and 0.7% in 2025. The figures will contribute to growing pressure on Rishi Sunak to do more to help households that are struggling with growing bills.
Despite what it called a “significant deterioration in prospects” for the UK and global economies, the MPC voted in favor of a fourth consecutive 0.25 percentage point increase in interest rates in a bid to curb inflation.
Consumer price index inflation is already 9.1% in the second quarter of this year – the highest level in four decades.
It expects inflation to fall sharply in 2023, before falling below the Bank’s 2 percent target interest rate in 2024 and reaching 1.3 percent in 2025.
The bank said it had decided to raise interest rates due to “tight labor markets, continuing signs of strong pressure on domestic spending and prices, and the risk of that pressure continuing.”
He also warned that there is a risk that energy prices will rise more than expected this winter, especially if Russian gas flows to Europe slow significantly.
“In such a scenario, European gas prices are likely to rise sharply and gas volumes could be normalized next winter, as EU gas stocks could disappear,” the bank said.
He warns that Russia’s war in Ukraine, combined with potential serious outbreaks of Covid in China, could lead to further disruptions in supply chains by raising inflation.
The 0.25% increase on Thursday brought the key interest rate to its highest level in 13 years, boosting monthly mortgage payments to borrowers on variable and tracking transactions.
Three members of the nine-member commission called for tougher action against inflation, calling for a 0.5 per cent increase in interest rates.
Markets are pricing in a series of further increases in the coming months, with the base rate reaching 2.5%. The MPC confirmed on Thursday that it believes “some degree of further tightening of monetary policy may still be appropriate in the coming months”.
The bank has also signaled that it may soon start selling £ 875 billion in government bonds it bought under its quantitative easing program.
Employees have begun work on a sell-off strategy, but the decision on whether to proceed has been postponed to future MPC meetings and remains dependent on economic circumstances.
Nevertheless, this marks a major turning point after 13 years of extremely loose monetary policy following the financial crisis.
This comes when the US Federal Reserve announced its biggest interest rate increase since 2000.
The central bank increased its target interest rate on federal funds to a range of 0.75% to 1%.
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