Bank of England raises interest rates by 0.5 percentage points

The UK is facing a protracted recession and the worst decline in living standards in more than 60 years, the Bank of England warned on Thursday, raising interest rates sharply and forecasting inflation at 13% by the end of the year.

Eight of the nine members of the Monetary Policy Committee voted in favor of raising interest rates by 0.5 percentage points to 1.75%, the largest increase in 27 years.

This follows aggressive moves by the European Central Bank and US Federal Reserve in the face of rising inflation. Silvana Tenreiro, an outside member, voted against the majority for a smaller increase of 0.25 percentage points.

Bank of England said that due to the recent surge in gas prices, inflation is now expected to top 13 percent at the end of the year – much higher than its May forecast – and remain at “very elevated levels” through 2023 before falling back to 2 -Percent target in two years.

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

The Bank of England is under growing political pressure to fight inflation after Foreign Secretary Liz Truss said she would try change your mandate if she wins the Conservative leadership competition and becomes Prime Minister of Great Britain.

With wages rising roughly twice as fast as inflation, BoE forecasts showed that after-tax household incomes will fall in real terms in both 2022 and 2023, even with the fiscal support announced by the government in May. A peak-to-trough drop of more than 5 percent in household income would be the worst on record since the data goes back to the 1960s.

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

Even as households are draining their savings, consumer spending was set to fall next year, slowing economic growth, according to the Bank of England. Its projections showed a much deeper contraction in gross domestic product than forecast in May, with the economy entering recession in the fourth quarter of 2022 and continuing to contract for five consecutive quarters.

The peak 2.1% drop in GDP would be comparable to that seen in the early 1990s, and the Bank of England said that even after the economy emerges from recession, it expects growth to be “very weak by historical standards.” “.

The MPC said the policy was “not on track”, suggesting that the 50 basis point rate hike was not necessarily the first of many.

The Bank of England’s central forecast, based on market expectations of a 3% hike in interest rates next year, showed inflation still in double digits in the third quarter of 2023, but falling back to the central bank’s 2% target a year later. If the Bank of England does not take any further policy action, its projections show that inflation will still fall below 2 percent by the end of 2024.

The Bank of England said that the uncertainty around its main forecast, which assumes energy prices will follow market expectations over the next six months but then remain unchanged, was “exceptionally large”, but alternative scenarios it has published continue to show “very high short-term inflation, a fall in GDP over the next year, and a marked fall in inflation thereafter.”

Rishi Sunak, the former chancellor, said the projected spike in inflation above 13 percent bolstered his claim that his Tory rival Truss would recklessly increase borrowing and cut taxes now.

“The bank acted today and it is imperative that any future government contain inflation rather than exacerbate it,” he said. “Increased borrowing will put upward pressure on interest rates, which will mean higher mortgage payments.”

Sunak’s team said a 0.5 percentage point hike in interest rates would cost the Treasury more than £6bn in higher debt servicing costs.

Truss claimed that Sunak was partly responsible for pushing the UK into recession due to a series of tax increases he imposed as Chancellor.