Bank of England hikes interest rates for tenth time in a row amid recession and warns of further action to tame inflation
The Bank of England today hiked interest rates for the tenth time in a row amid a recession to the highest level since the financial crisis in 2008 and warned more increases may be needed to tame inflation.
The nine-strong committee of rate setters that set the base level of borrowing costs in the UK voted 7-2 in favour – including governor Andrew Bailey – of kicking rates 50 basis points higher to four per cent, the highest level in nearly 15 years.
Further pain has been heaped on households and businesses despite the Bank forecasting Britain will be in recession for the whole of this year and most of next year.
The central bank’s new economic forecasts were upgraded from projecting the deepest contraction since the early 1990s back in November. However, the length of the reversal is broadly the same at 15 back-to-back months.
GDP is expected to shrink 0.5 per cent and 0.25 per cent in 2023 and 2024 respectively, slightly gloomier than projections released by the International Monetary Fund (IMF) earlier this week that said the UK would be the only rich economy to contract this year but grow next year.
The economy is poised to end up around one per cent smaller at the end of the recession and could still be beneath its pre-pandemic size by 2026. The cumulative hit is much smaller than the more than six per cent wiped off of GDP during the financial crisis.
The Bank’s shallower recession forecast was partly caused by market interest rates falling rapidly from November’s meeting when they topped five per cent due to Liz Truss’s mini budget rocking investor confidence in the UK.
Its forecasts are based on market rate expectations, which are now for a peak of 4.4 per cent, boosting its GDP projections.
Central banks have jacked up interest rates sharply
Chancellor Jeremy Hunt backed the Bank’s hike and said he and prime minister Rishi Sunak will resist “the urge right now to fund additional spending or tax cuts through borrowing, which will only add fuel to the inflation fire and prolong the pain for everyone” at the 15 March budget.
Despite the long recession, the Bank still reckons “further tightening in monetary policy” will be needed if “more persistent” inflationary pressures stick around.
Bailey said it is “too soon to declare victory” on inflation and that the MPC “need to be absolutely sure we really are turning a corner on inflation” before mulling rate cuts.
However, Bailey and co dropped the “forcefully” term which they have used for several months to describe how aggressive their response to inflation will be.
“Below-target inflation forecasts, more muted language on future tightening, and a warning about the impact of past rate hikes, all signal that bank rate is close to peaking. We expect one further 25bp rate hike in March, though we think a rate cut is unlikely for at least a year,” James Smith, developed markets economist at ING, said.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, agreed with that sentiment, but said no such hike will happen next month.
“The MPC’s new forecasts imply it thinks it will not need to raise Bank Rate further over the coming months,” he said.
However, Paul Dales, chief UK economist at Capital Economics, said he is not “not convinced things will work out as nicely as the Bank expects,” adding inflation could hang around if wages keep racing, forcing Bailey and co to bump rates to 4.5 per cent.
Bumper pay rises driven by a combination of firms hiking wages to lure and retain workers amid a labour shortage and staff demanding raises to offset inflation is the main danger to embedding high inflation in the economy, the Bank said.
Private sector pay is growing at a rate of more than seven per cent, according to latest Office for National Statistics figures, a record high, but still trailing price rises.
Structurally weaker supply potential caused by the global energy shock and Brexit also risks keeping inflation higher, the Bank said.
Inflation has dropped two times in a row for the first time since the beginning of the Covid-19 crisis, down from a peak of 11.1 per cent in October to 10.5 per cent in December.
The Bank reckons it will fall rapidly this year but will not get back to near its two per cent target until the middle of next year.
Markets have started pricing in rate cuts by governor Bailey and rest of the monetary policy committee (MPC) toward the end of this year, mainly to jolt the economy out of a slump as inflation recedes.
Two members of the nine strong group – Swati Dhingra and Silvana Tenreyro – backed keeping rates unchanged at 3.5 per cent for the second meeting in a row.
Central banks have done the bulk of the heavy monetary tightening over the last year and they are now trying to avoid dealing too much damage to their respective economies without letting inflation stick around, aiming for the so-called “soft landing”.
Last night, the US Federal Reserve kicked rates 25 basis points higher, the smallest rise since its first increase in the current tightening cycle in March 2022.
The European Central Bank today also pumped borrowing costs 50 basis points higher and committed to launch further such increases this year.
President Christine Lagarde has trailed Bailey and Fed chair Jerome Powell in the race to squeeze inflation.