Economy · August 4, 2022

The Bank of England raises interest rates by 0.5 percentage points

Britain faces a protracted recession and the worst standard of living squeeze in more than 60 years, the Bank of England warned Thursday that it had drastically hiked interest rates and expects inflation to hit 13% by the end of the year. end of year.

Eight of the nine members of the Monetary Policy Committee voted to raise interest rates by 0.5 percentage points to 1.75 percent, the highest level since the global financial crisis.

This follows the aggressive steps of the European Central Bank and the US Federal Reserve in the face of soaring inflation. Silvana Tenreyro, an outside member, voted against the majority for a 0.25 percentage point lower increase.

The BoE said that due to the latest hike in gas prices, it now expects inflation to rise more than 13% at the end of the year – much higher than its May forecast – and remain at “levels. very high “throughout 2023 before falling back to the 2% target within two years.

The pound fell 0.4% to $ 1.209 after the news, while the 10-year UK government bond yield fell 0.07 percentage points to 1.85%.

The nearly doubling of wholesale gas prices since May could push the typical annual household fuel bill from just under £ 2,000 to around £ 3,500 when regulated prices rise in October, the BoE said.

With wages rising to around half the inflation rate, his forecasts showed that after-tax household income would decline in real terms in both 2022 and 2023, even after taking into account the government’s announced fiscal support. in May. more than 5% of household income would be the worst ever recorded, with data dating back to the 1960s.

Bank of England benchmark rate (%) line chart showing UK interest rates rise by half a point for the first time in 27 years

Even with households running out of savings, consumer spending is set to decline over the next year, the BoE said, dragging down economic growth. His forecasts showed a much deeper-than-expected GDP contraction in May, with the economy entering recession in the fourth quarter of 2022 and continuing to shrink for five successive quarters.

A peak-to-low drop in GDP of 2.1 percent would be comparable to that seen in the early 1990s, and the BoE said that even once the economy is out of recession, it expects “very weak growth for” historical standards “.

The BoE’s aggressive tightening of monetary policy will exacerbate the immediate squeeze on household incomes, but the central bank said it could not prevent an adjustment caused by the major global shocks.

The MPC said it would take action if a long period of high inflation caused by global factors led to “more lasting” domestic price pressures, repeating its earlier guidance that it would “act forcefully” if necessary. However, he also pointed out that the policy “was not on a predetermined path”, suggesting that the 50 basis point rate hike wasn’t necessarily the first of many.

The BoE’s central forecast, which is based on the market’s expectations of interest rates rising to 3% next year, showed inflation still double-digit in the third quarter of 2023, but a year later it was returning to its target. 2% set by the central bank. If the BoE does not take further policy action, its forecasts show that inflation would still fall below 2% by the end of 2024.

The BoE said the uncertainty surrounding its core forecasts – which assumes energy prices will follow market expectations for the next six months but then remain unchanged – was “exceptionally large”, but that the published alternative scenarios showed still “very high short-term inflation, a drop in GDP in the next year and a marked decline in inflation thereafter”.

The bank is under increasing political pressure to curb inflation after Liz Truss said she would try to change her tenure if she won the Tory leadership contest and became UK Prime Minister.

The BoE also planned to begin monthly sales of the £ 875bn of assets it has accumulated under its quantitative easing program since 2009. It said it intended to start selling gilts shortly after the September meeting, with the aims to reduce its shares by approximately £ 80 billion during the first 12 months. Given the profile of gilts maturing over this period, this would imply a sales program of around £ 10bn per quarter.