The Bank of England today raised interest rates by the most in 27 years, despite warning that a long recession is on the way, as it rushed to stifle a rise in inflation now set to peak at 13%.
Due to a sharp rise in energy prices caused by Russia’s invasion of Ukraine, the Bank of England’s Monetary Policy Committee voted 8-1 to raise the Bank Rate by half a percentage point to 1.75% – the highest level since late 2008 – from 1, 25%.
The 50 basis point increase had been expected by most economists in a Reuters poll as central banks around the world try to stem the rise in prices.
MPC member Silvana Tenreyro voted alone for a smaller increase of 25 points.
The Bank of England warned that the UK was facing a recession with a peak-to-trough fall in output of 2.1%, similar to a slump in the 1990s but much smaller than that from Covid-19 and the downturn caused by the 2008 09 global financial crisis.
The UK economy would start to shrink in the last quarter of 2022 and shrink throughout 2023, making it the longest recession since the global financial crisis.
To kick off the slowdown, consumer price inflation was now likely to peak at 13.3% in October – the highest since 1980 – mainly due to rising energy prices following Russia’s invasion of Ukraine.
That would leave households facing two straight years of declines in their disposable incomes, the biggest squeeze since records began in 1964.
UK consumer price inflation hit a 40-year high of 9.4% in June, already more than four times the Bank of England’s 2% target.
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This has sparked industrial action and is putting pressure on whoever succeeds Boris Johnson as Britain’s next prime minister to come up with further support.
The bank had previously expected inflation to peak above 11% and almost no growth in the UK economy before 2025 at the earliest.
In its new forecasts, the Bank of England saw inflation falling back to 2% over two years as the economy took its toll on demand.
The Bank of England has now raised interest rates six times since December, but today’s move was the biggest since 1995.
Pressure on Gov. Andrew Bailey and colleagues to take bigger steps intensified after recent big rate hikes by the U.S. Federal Reserve, the European Central Bank and other central banks.
These moves weakened the value of the pound, which could increase inflation.
The Bank of England reiterated that it was ready to act forcefully if necessary to stem more persistent inflationary pressures.
But it stressed there were “extremely large” uncertainties about the economy – which could make the slowdown more or less severe than its core forecasts – and it would assess what its next steps should be as events unfold.
“The police are not on a predetermined path,” the Bank of England said today.
“The extent, pace and timing of any further changes in the Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures,” it added.
Bank of England Governor Andrew Bailey said today that returning UK inflation to the 2% target was an absolute priority and that all options were on the table at future policy meetings.
“Returning inflation to the 2% target remains our absolute priority. There are no ifs and buts about that,” Bailey told a news conference.
“All options are on the table for our September meeting and beyond,” he added.
On top of everything else, the Bank of England’s anti-inflation record has been called into question by Liz Truss, the front-runner to be Britain’s next prime minister.
She wants to set “a clear direction” for monetary policy and review the Bank of England’s mandate.
The Bank of England also said today that it expects to start selling down its huge stock of government bonds, with active sales of around £10 billion per quarter, shortly after its next meeting in mid-September.
Gilt holdings peaked at £875bn in December and have since fallen to £844bn after the bank stopped reinvesting proceeds from maturing bonds in February.
The UK Chancellor of the Exchequer is confident that the UK can overcome economic challenges
British Chancellor of the Exchequer Nadhim Zahawi said he was confident the country was taking the right steps to overcome global economic challenges, after the Bank of England raised interest rates and warned inflation would top 13%.
“Along with many other countries, Britain is facing global economic challenges and I know these forecasts will be worrying for many people,” he said in a statement.
“I am confident that the actions we are taking mean we can also overcome these global challenges,” he added.
“Tackling the cost of living is a top priority and we have taken steps to support people through these tough times,” Zahawi said in today’s statement.
“We are also taking important steps to bring inflation under control through a strong, independent monetary policy, responsible tax and spending decisions and reforms to boost our productivity and growth,” he said.
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