UK central bank raises rates, warns of recession

Andrew Bailey

The UK central bank on Thursday raised interest rates to their highest since 2009 — hiking borrowing costs by a quarter-point to 1% to fight inflation.

The move came even as the Bank of England (BoE) issued a warning that the UK risks falling into recession.

The BoE’s nine rate-setters voted 6-3 for the rise from 0.75%, with Catherine Mann, Jonathan Haskel and Michael Saunders calling for a bigger increase, to 1.25%, to eliminate the risk of the inflation surge becoming embedded in the economy.

The BoE’s move was its fourth consecutive rate hike since December, the fastest increase in borrowing costs in 25 years.

BoE governor Andrew Bailey said: “I recognize the hardship this will cause people in the UK, particularly those on lower incomes.

“The biggest driver is the real-income shock, which is coming from the change in the terms of trade, coming particularly from energy prices.”

While the bank predicts the UK will avoid a technical recession — two consecutive quarters of contraction — it said output will collapse by close to 1% in the final quarter of this year.

In 2023, annual GDP is expected to shrink by 0.25%.

The UK central bank’s move followed the US central bank’s announcement on Wednesday of its biggest hike in interest rates since 2000 when the US Federal Reserve’s policy-setting Federal Open Market Committee (FOMC) voted unanimously to increase the benchmark rate by a half percentage point.

The increase in the FOMC target for the federal funds rate to a range of 0.75% to 1% follows a quarter-point hike in March that ended two years of near-zero rates.

“Based on their updated assessment of the economic outlook, most members of the Committee judge that some degree of further tightening in monetary policy may still be appropriate in the coming months …” said the BoE.

“As Bank Rate is now being increased to 1%, and consistent with the MPC’s previous guidance, the Committee will consider beginning the process of selling UK government bonds held in the Asset Purchase Facility.

“The Committee reaffirms that the decision to commence sales will depend on economic circumstances including market conditions at the time, and that sales would be expected to be conducted in a gradual and predictable manner so as not to disrupt the functioning of financial markets.

“The Committee recognises the benefits of providing market participants with clarity on the framework for any potential sales programme.

“The Committee has therefore asked Bank staff to work on a strategy for UK government bond sales, and will provide an update at its August meeting.

“This will allow the Committee to make a decision at a subsequent meeting on whether to commence sales.”


Luke Bartholomew, senior economist, Abrdn: “While the decision to hike rates by 25bps to 1% was widely expected, the composition of votes and the large forecast changes has given investors a lot to digest.

“The Monetary Policy Committee seems to be divided at least three ways, with three of the nine members voting for a 50bps hike, while a further two members disagree with the Committee’s assessment that further rate hikes from here will be necessary.

“These divisions reflect just how difficult it is to set policy at the moment, with the economy facing multiple conflicting shocks.

“The Bank has revised its inflation forecasts higher, while it is now expecting a small contraction in the economy in 2023.

“This is a toxic economic combination, which requires the Bank to make difficult trade-offs over how much it prioritises supporting growth or bringing inflation down.

“Part of the division in the MPC can therefore probably be accounted for by different policy makers assessing this trade-off slightly differently.

“All this means it will be remain difficult to extract a clear signal from the Bank about where interest rates are likely to eventually settle, which is likely to be a source of ongoing volatility.”

Kevin Brown, savings specialist at Scottish Friendly: “This rate hike is no surprise to anyone, but too little and far too late.

“The bank should be doing more to combat painful inflation increases than it is currently offering.

“Six months ago inflation was already at 5.1% and the bank rate was just 0.1%. Now we’re at 6.2% and rising, and the bank rate is just 1%. It patently acted too slowly in the first place.

“The Bank of England’s one job above all others is to control inflation and it is not doing enough. Action in the US yesterday evidences this.

“The MPC is obviously walking a narrow tightrope here, with economic growth so fragile but the decision will have to come at some point to halt the inflationary pressure as households cannot bear it for long.

“This is evidenced by soaring credit card usage and plummeting savings levels. For those who are saving, cash is still a terrible place to be with locked in real losses, even if savings account rates are ticking up in step with the BoE.

“Celebrating savings interest rates going up to 1% while the real value of your cash is being decayed by 8% inflation is like being sold a car with no wheels and then getting charged for not driving it out of the forecourt – it’s just an insult to savers and hard working families.

“Despite market volatility, long term savings really are still best placed in a diverse portfolio including the stock market, bonds, property and cash.

“For many households, the ability to contribute to long-term savings is being severely hampered by the cost-of-living crisis.

“But it is still an essential aspect of household budgeting and shouldn’t be cast aside. Even very small monthly contributions can make a big difference in the future.”

Hinesh Patel, portfolio manager, Quilter Investors: “Today’s move resembles shuffling deck chairs on the Titanic.

“The Bank will be concerned that inflation expectations in the economy are unanchored from long-term target.

“Whilst the Bank has shown good form at soothing volatility in domestic funding markets, it has little control of external forces with the exception of trying to support the FX rate.

“As was widely expected, the Bank of England has once again had no choice but to hike rates in its attempt to contain inflation at an appropriate level, this time to 1%.

“This marks the fourth consecutive rate rise since the BoE began its fight against inflation back in December 2021 when it first raised rates following the pandemic, and the Bank Rate now sits at a level not seen since the aftermath of the financial crisis in early 2009.

“Inflation hit a 30-year high of 7% in March, and the BoE predicts it will hit just over 9% during the second quarter and likely higher still in the second half of the year, averaging slightly over 10% at its peak in 2022 Q4.

“Given this, the BoE had no choice but to increase rates further still. It is continuing to build in some insurance now should there be a slowdown in economic growth or the jobs market stumbles.

“With the significant economic impact of the Russia-Ukraine war alongside a multitude of other global risks and plunging consumer confidence, growth will no doubt be challenged and the Bank may be forced to stop tightening even as soon as this year.

“For now, however, it must continue on its path to prevent sterling devaluing further and intensifying the household squeeze.

“Savings rates could improve following this rate rise, though will only be marginal offset the cost of living crisis currently being faced.

“With the Fed moving harder with rates yesterday evening, many will have hoped to have seen the same from the BoE today. With inflation continuing to soar, the Bank risks doing too little too late.

“While the BoE may be putting up a confident front, given the current delicate market environment, we could easily see inflation continue to rise above the BoE’s forecasts.

“Investors will need to continue to watch the data and markets closely and allocate accordingly. Diversification, active management and prudency remain key.”

Victoria Scholar, head of investment, Interactive Investor: “The monetary policy committee voted 6-3 in favour of the hike, with more members dovishly dissenting this time by electing for no change to the bank rate.

“At the previous meeting in March, only Deputy Governor Jon Cunliffe voted to keep rates on hold, suggesting that the central bank is becoming increasingly concerned about tipping the UK economy into recession.

“The Governor Andrew Bailey himself said the bank is walking a ‘narrow path’ between growth and inflation as both macro indicators journey in the opposite and wrong directions …

“The latest indications on the UK points to an increasingly fragile economy with consumer confidence close to the lowest level since records began almost 50 years ago, with an uninspiring 0.1% GDP growth in the latest data for February and now with the IMF suggesting that UK GDP will slow to the worst among the G7 next year.

“After last week’s data saw the US economy unexpectedly contract for the first time since mid-2020 there are growing concerns that the UK could be on track for a similar fate as the risk of a recession intensifies.

“Meanwhile soaring food and energy prices have pushed inflation to 30-year highs with the consumer price index on track to surpass 8 or 9% …

“Financial markets and economists are divided over the number of rate hikes the central bank will carry out in the months ahead.

“According to the overnight index swaps (OIS) market ahead of the decision, traders are pricing in around six hikes including today’s move to lift the bank rate to around 2.25% by December whereas more prudent economists see interest rates moving a lot more slowly, reaching 1.5% by early 2023.

“Markets have been impacted by US market pricing amid expectations of more aggressive tightening from the Fed as well as liquidity issues, suggesting their expectations could be getting ahead of themselves, while economists’ forecasts are updated a lot less frequently and so could be revised higher soon.

“When combined, it suggests that both will meet somewhere in the middle … 

“Although the Bank of England passively started to wind down its balance sheet in February by not reinvesting maturing assets, active gilt sales are the next step, which the MPC says will start in September with what is expected to be a steady as she goes approach to avoid the risk of derailing the economy.

“Until September there will be no change to the bank’s bond buying programme which is unsurprising given the volatility in financial markets as well as the macroeconomic uncertainty stemming from the war in Ukraine …

“The pound initially spiked at midday before reversing those gains shedding more than 1% to push below $1.25.

“After an initial rally late last year when the Bank of England led the pack by beginning its interest rate lift-off in December, the pound peaked in January and has since seen the resumption of its downtrend.

“Sterling’s carry trade advance was short-lived after other central banks including the Fed started to indicate more seriously that they were also planning shift towards monetary tightening to combat inflation.

“As a result, GBPUSD has slumped from above $1.37 down to below $1.25 with the possibility of further weakness to come for the pound as the UK economy deteriorates …

“Although today’s decision is expected aimed at having a cooling economic impact, particularly on flexible mortgage demand, the Bank of England’s rate hiking path is yet to have made a notable dent in the mortgage lending data, given that monetary policy works with a considerable lag.

“The latest figures for March from the Bank of England saw mortgage lending rebound to a six-month high, driven by a robust housing market and perhaps as individuals and families try to lock in more favourable mortgage rates before rates push even higher.”

Tony Syme, macroeconomic expert, University of Salford Business School: “Living standards are now being eroded by inflation and the policies to address it will only make the living standards crisis even worse.

“The latest rise comes a day after the Federal Reserve announced the largest increase in interest rates since 2000 and two days after the Reserve Bank of Australia raised interest rates for the first time in more than a decade. They all cite the same reason: rising inflation.

“But that pursuit of the stable prices is likely to have serious consequences on a British economy that is fundamentally unbalanced. The Bank of England is only making matters worse.

“It should focus on co-ordinating with the Treasury to boost business investment and raise productivity. That will help to raise living standards and keep domestic inflation low in the long run, while changes to government policies around skills training and migration could tackle the current labour shortage in the short run.

“A rise in living standards is driven by rises in productivity and these are sustained by business investment.

“But the latest figures for business investment show that it is still 8.6% lower than it was in 2019 and, following a survey of its members, the British Chambers of Commerce recently revised downwards it projection for business investment growth in 2022 by over 30%.

“Without investment to drive forward permanent increases in productivity and, in the absence of any other supply-side factors to boost the British economy, living standards can only increase via short-term boosts to demand via trade, household consumption and government expenditure.

“While Brexit has had a negative impact on the UK’s trade balance, it has been the maintenance of household consumption throughout the pandemic and the very large rise in government expenditure that has created the growth in the economy in recent times.

“Interest rate increases raise the cost of borrowing for both households and businesses. Reductions in household spending have a negative effect on the economy in the short run. Reductions in business investment have a negative effect on the economy in the long run.

“Little wonder that the GfK Consumer Confidence index is now -38, the second-lowest reading since records began almost 50 years ago, and the Institute of Directors’ economic confidence index fell from -4 in February to -36 in April.”