LONDON — The Bank of England raised interest rates by 50 basis points on Thursday, its biggest increase since 1995, and forecast Britain’s longest recession since the global financial crisis.
The sixth consecutive increase takes borrowing costs to 1.75% and marks the first half-point increase since the bank was made independent of the UK government in 1997.
The Monetary Policy Committee voted by an 8-1 majority in favor of the historic half-point hike 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 the restriction of gas supplies from Russia to Europe and the risk of further restrictions,” the MPC said in a statement. his statement.
“As this feeds through to retail energy prices, it will worsen the decline in real UK household incomes and further increase UK CPI inflation in the near term.”
UK energy regulator Ofgem raised the energy price cap by 54% from April to cope with soaring global costs, but is expected to rise further in October as annual bills for household energy to exceed £3,600 ($4,396).
The bank now expects headline inflation to peak at 13.3% in October and remain at elevated levels for much of 2023, before falling to its 2% target in 2025.
The MPC noted that the labor market remains tight, with elevated domestic cost and price pressures, adding that there is a risk that a “longer period of externally generated price inflation could lead to more lasting domestic pressures on prices and wages”.
“The labor market remained tight, with an unemployment rate of 3.8% in the three months to May and job vacancies at historically high levels,” the MPC said. “As a result, and consistent with the latest agent survey, underlying nominal wage growth is expected to be higher than in the May report during the first half of the forecast period.”
The pound lost more than 0.5% against the dollar after the Bank’s announcement, trading at around $1.209, while the FTSE 100 index climbed 0.5%.
Cost of living crisis
At a news conference after the announcement, Bank of England Governor Andrew Bailey said Russia’s war shock in Ukraine is now the biggest contributor to Britain’s inflation “d ‘a certain way’.
“There is an economic cost to war, but I must be clear, that will not prevent us from setting monetary policy to bring inflation back to the 2% target,” he added.
Markets had largely priced in the more aggressive approach at the August meeting, after UK inflation hit a new 40-year high of 9.4% in June, as food and energy continued to rise, deepening the country’s historic cost of living crisis.
Bailey promised last month that there would be “no ifs or buts” to the central bank’s commitment to bringing inflation back towards its 2% target.
Analysts had been keen to assess the Bank’s language, particularly its earlier commitment to act “forcefully” on 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 is hitting the less well off harder, but if we don’t act to prevent inflation from persisting, the consequences will be worse later, and that will require bigger increases in interest rates.”
The Bank said it intended to launch active sales of government bonds worth around £10 billion ($12.1 billion) per quarter from September, under reserve the final go-ahead from the decision-makers.
The Bank issued a gloomy outlook for economic growth, suggesting the latest gas price hike has led to a further “significant deterioration” in the outlook for activity in the UK and the rest of Europe.
The MPC now projects 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 starts to contract.
“Growth thereafter is very weak by historical standards. The contraction in output and weak growth prospects beyond that primarily reflect the large negative impact of the sharp rise in global energy and commodity prices. exchangeable on real UK household incomes,” the MPC said in its monetary report. policy report.
Forecasts warn of a 2.1% drop in output from peak to trough as the economy begins to contract in the fourth quarter of 2022 and contracts throughout 2023.
BOE Governor Andrew Bailey warned that the Bank was taking a “narrow path” between growth and inflation.
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Luke Bartholomew, senior economist at Abrn, said the Bank’s forecast clearly shows how difficult the UK’s economic situation is compared to other major countries.
“The Bank is simultaneously forecasting a long recession beginning later this year and an even higher inflation spike. This is a toxic economic combination, one that the central bank would struggle to navigate at the best of times. let alone when it is increasingly dragged into the political spotlight,” he said.
Liz Truss, the favorite to win the Conservative Party leadership race to succeed Boris Johnson as Prime Minister, is reportedly considering reviewing the Bank of England’s inflation mandate and the extent of its independence from government. – vis-à-vis the central government.
“With inflation now expected to last longer, it is difficult to see how the Bank can move any earlier towards supporting the economy. As such, investors should expect further rises in interest rates from here, even if the markets and the economy are struggling,” he added. adds Bartholomew.