Bank of England hikes rates again as it predicts recessionby
The Bank of England has committed to the biggest interest rate increase since becoming independent 25 years ago, as it expects the UK to plunge into recession by the end of the year.
With soaring prices and the UK barrelling towards a recession, interest rates have increased today by half-point to 1.75%. This marks the sixth consecutive announcement where the UK central bank has increased the rates, only this time the 0.5% hike is the largest increase in 27 years.
The increase comes as the worst inflation in 40 years is projected to peak at just over 13% by the end of the year, outstripping the central bank’s previous prediction of 11%. The Bank of England (BoE) also expects the UK to enter recession from the fourth quarter of this year.
The measures are being rolled out to fend off these inflationary pressures, but by the current projections from the International Monetary Fund (IMF), the UK is set for the slowest growth in the G7 next year. In a report released last week, the IMF forecasted that the UK’s growth in 2023 will fall to 0.5%.
Pierre-Olivier Gourinchas, director of research of the IMF, said: “The outlook has darkened significantly since April. The world may soon be teetering on the edge of a global recession, only two years after the last one.”
The nine members of the monetary policy committee (MPC) voted by a majority of 8 to 1 to increase to 1.75%. The one member of the committee in the minority voted to increase by 0.25% to 1.5% as they have done for the past consecutive meetings of 0.25% to 0.5%.
Today’s announcement was a shift in gears from the central bank, which has only chosen to increase interest rates in recent months by 0.25%.
The BoE may have made a record increase to interest rates in an attempt to tame inflation, but their efforts still train the Federal Reserve in the United States, who increased interest rates for the second month in a row by 0.75%.
The BoE repeated concerns about inflation overshooting its 2% target to 13% at the end of the year. It said inflation is expected to “remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead”.
The bullish half-point increase comes after the BoE stated in June that it would “act forcefully” in response to any “persistent inflationary pressures”.
The issues contributing to rising inflation haven’t changed since the last announcement where the BoE pinned the blame on large increases on global energy and other tradable goods prices with the former greatly exacerbated by the war in Ukraine.
These challenges haven’t cleared up. “Inflationary pressures in the United Kingdom and the rest of Europe have intensified significantly since the May Monetary Policy Report and the MPC’s previous meeting. 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. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase UK CPI [consumer price index] inflation in the near term.”
The BoE also expects that the typical annual dual-fuel bill will rise from just under £2,000 to around £3,500 in October and also confirmed that gross domestic product (GDP) in the UK is slowing. “The latest rise in gas prices has led to another significant deterioration in the outlook for activity in the United Kingdom and the rest of Europe. The United Kingdom is now projected to enter recession from the fourth quarter of this year.”
The current rate of inflation is 9.4%.
Inflation to dissipate over time
The BoE is hopeful though that inflationary pressures are going to dissipate over time. “Global commodity prices are assumed to rise no further, and tradable goods price inflation is expected to fall back, the first signs of which may already be evident. Although the labour market may loosen only slowly in response to falling demand, unemployment is expected to rise from 2023.
“Domestic inflationary pressures are therefore expected to subside in the second half of the forecast period, as the increasing degree of economic slack and lower headline inflation reduce the pressure on wage growth. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.”
The MPC will meet and announce any further changes to the base rate on 15 September.
AccountingWEB readers are likely to be supportive of today’s announcement if their reaction to the last increase was anything to go by. AccountingWEB member Robbie White said back in June that the rates needed to be raised further to 4–5% and predicted then that “11% inflation by the year end seems optimistic”.
Not everybody was in favour of the increase. “Increasing interest rates will just have the exact opposite effect – it will just push prices up on the whole for the majority of the population,” said AccountingWEB member Viciuno in June. “Price rises are not being driven by excess spending by the population, but by factors outwith the control of the BoE. The largest inflationary pressure at the moment is the price of gas and oil – and no amount of interest rate hikes will solve that problem.”
Lord Sikka, the Emeritus Professor of Accounting at the University of Essex, called hiking interest rates to fight inflation a “crazy policy” days before the BoE’s announcement. “It increases bank profits. It harms SMEs and people in debt who are not awash with cash,” he wrote on Twitter. “It will have little impact on oil/gas and other profiteers. Government needs to increase taxes on the rich and profiteering corporations.”
Fair tax campaigner Richard Murphy echoed this on Twitter: “What I want to know is how increasing these rates will help people pay their gas, electricity, rent, mortgage, council tax, water and broadband bills? If it won’t, why are they deliberately making life impossible for millions?”
Meanwhile, Mazars in June raised concerns about the effect the rate rise will have on UK businesses. The accountancy firm anticipated that the last increase of 0.25% would increase the cost of borrowing and force companies to shut their doors. “If interest rates were to rise to 2%, interest payments for businesses would rise by a further £3.7bn to £14.9bn,” Mazars said.