The Bank of England on Thursday hiked interest rates by 50 basis points, its largest single increase since 1995, and projected the U.K.’s longest recession since the global financial crisis.
The sixth consecutive increase takes borrowing costs to 1.75% and marks the first half-point hike since the Bank was made independent from the British government in 1997.
The Monetary Policy Committee voted by a majority of 8-1 in favour of the historic half-point hike and cited rising inflationary pressures in the U.K. and the rest of Europe since its previous meeting in May.
“That largely reflects a near doubling in wholesale gas prices since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs,” the MPC said in its accompanying statement.
“As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase U.K. CPI inflation in the near term.”
Britain’s energy regulator Ofgem increased the energy price cap by 54% from April to accommodate soaring global costs but is expected to rise by a greater degree in October, with annual household energy bills predicted to surpass £3,600 ($4,396).
The Bank now expects headline inflation to peak at 13.3% in October and to remain at elevated levels throughout much of 2023, before falling to its 2% target in 2025.
“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.”
Luke Bartholomew – Senior Economist, ABRDN
Markets had broadly priced in the more aggressive approach at the August meeting, after U.K. inflation hit a new 40-year high of 9.4% in June as food and energy prices continued to surge, deepening the country’s historic cost-of-living crisis.
Bank of England Governor Andrew Bailey vowed last month that there would be “no ifs or buts” in the central bank’s commitment to returning inflation toward its 2% target.
Analysts had been keen to assess the Bank’s language, particularly its previous commitment to act “forcefully” on inflation, and the MPC retained that language in Thursday’s report.
The Bank also said that it intends to start active government bond sales worth approximately £10 billion ($12.1 billion) per quarter from September, subject to a final green light from policymakers.
Recession incoming
The Bank issued a dire outlook for economic growth, suggesting that the latest gas price rise has led to another “significant deterioration” in the outlook for activity in the U.K. and the rest of Europe.
The MPC now projects that the U.K. will enter recession from the fourth quarter of 2022, and that the recession will last five quarters as real household post-tax income falls sharply in 2022 and 2023 and consumption begins to contract.
“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 forecast warns of a peak-to-trough fall in output of 2.1%, with the economy beginning to shrink in the fourth quarter of 2022 and contracting throughout 2023.
Luke Bartholomew, the senior economist at Abrdn, said the Bank’s forecasts make clear just how difficult the U.K.’s economic picture is compared with other major countries.
“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.
Liz Truss, the favourite to win the Conservative Party leadership contest 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 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.
Sterling was down over 0.4% against the dollar following the Bank’s announcement, trading at around $1.209, while the FTSE 100 index climbed 0.4%.
