The Bank of England launches the biggest interest rate hike in 27 years

LONDON — The Bank of England raised interest rates by 50 basis points on Thursday, their biggest increase since 1995, projecting Britain’s longest recession since the global financial crisis.

The sixth consecutive increase brings 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 by an 8-1 majority in favor of the historic half-point increase, citing mounting inflationary pressures in the UK and the rest of Europe since its previous meeting in May.

“That largely reflects a near doubling in wholesale gas prices since May, due to Russia’s restriction of gas supplies to Europe and the risk of further restrictions,” the MPC said in the accompanying statement.

“As this feeds through to retail energy prices, it will exacerbate the decline in real UK household income and further push up UK CPI inflation in the near term.”

Britain’s energy regulator Ofgem raised the power price cap by 54% from April to match rising global costs, but it is expected to rise further in October, with annual bills forecast to rise. household energy bills exceed £3,600 ($4,396).

The bank now expects headline inflation to peak at 13.3% in October and remain elevated for much of 2023, before falling to its 2% target in 2025.

The MPC noted that the labor market remains tight, with internal cost and price pressures elevated, adding that there is a risk that a “longer period of externally generated price inflation will lead to more lasting internal price and wage pressures.”

“The labor 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 according to the latest Agents survey, underlying nominal wage growth is expected to be higher than in the May Report during the first half of the forecast period.”

Sterling fell more than 0.5% against the dollar following the bank’s announcement, trading at around $1,209, while the FTSE 100 Index rose 0.5%.

cost of living crisis

In a press conference following the announcement, Bank of England Governor Andrew Bailey said the impact of Russia’s war in Ukraine is now the biggest contributor to UK inflation “in some way”.

“The war has an economic cost, but I must be clear, it will not divert us from establishing a monetary policy to bring inflation to the 2% target,” he added.

Markets had widely 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 prices continued to rise , which deepened the country’s historic cost-of-living crisis.

Bailey promised last month that there would be no “ifs or buts” in the central bank’s commitment to bring inflation back to its 2% target.

The Bank is simultaneously forecasting a long recession starting later this year and an even higher spike in inflation. This is a toxic economic mix, one that would be difficult for the central bank to manage at the best of times, let alone when it finds itself drawn increasingly into the political spotlight.

Lucas Bartholomew

Senior Economist, Abrdan

Analysts were keen to assess the Bank’s language, particularly its earlier commitment to act “strongly” 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 hits the poor hardest, but if we don’t act to prevent inflation from becoming persistent, the fallout will be worse later on, and that will require further increases in interest rates.”

The Bank said it intends to start active sales of government bonds worth about £10bn ($12.1bn) per quarter from September, subject to a final green light from policymakers.

incoming recession

The Bank issued a dire outlook for economic growth, suggesting that the latest rise in gas prices has caused another “significant deterioration” in the outlook for activity in the UK and the rest of Europe.

The MPC now projects that the UK will enter a recession from the fourth quarter of 2022, with the recession lasting five quarters as real after-tax household income falls sharply in 2022 and 2023 and consumption begins to contract. .

“Since then, growth has been very weak by historical standards. The contraction in output and the weak growth outlook beyond that predominantly reflect the significant adverse impact of sharp increases in global energy and tradable goods prices.” in real UK household income,” the MPC said in its monetary report. policy report.

The forecast warns of a peak-to-trough drop in output of 2.1%, with the economy beginning to contract in the fourth quarter of 2022 and contracting throughout 2023.

BOE Governor Andrew Bailey warned that the bank is treading a “narrow path” between growth and inflation.

Mayor Bloomberg | Mayor Bloomberg | fake images

Luke Bartholomew, senior economist at Abrdn, said the Bank’s forecasts make it clear how difficult the UK’s economic outlook is compared to other major countries.

“The Bank is simultaneously forecasting a long recession starting later this year and an even higher spike in inflation. This is a toxic economic mix, one that would be difficult for the central bank to navigate at best, and much less when it is getting more and more difficult”. be dragged into the political spotlight,” she said.

Liz Truss, the favorite to win the Conservative Party leadership race and succeed Boris Johnson as prime minister, is reportedly considering reviewing the Bank of England’s inflation mandate and the extent of its independence from central government.

“With inflation now expected to stick around longer, it’s hard to see how the Bank can pivot into supporting the economy anytime sooner. As such, investors should expect further interest rate increases from here, even when markets and the economy are struggling. added Bartholomew.

Leave a Comment