UK central bank ups rates, flags recession -reaction

The UK’s central bank on Thursday announced its biggest interest rate hike in 27 years and warned the UK is heading for more than a year of recession.

As predicted by most economists, the Bank of England increase rates by 0.5% to 1.75%.

The central bank warned that CPI inflation in the UK is now expected to rise from 9.4% in June to just over 13% in Q4 of 2022, and to remain at “very elevated levels” throughout much of 2023,

“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,” said the central bank.

“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 inflation in the near term.

“CPI inflation is expected to rise more than forecast in the May Report, from 9.4% in June to just over 13% in 2022 Q4, and to remain at very elevated levels throughout much of 2023, before falling to the 2% target two years ahead.

“GDP growth in the United Kingdom 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.

“Real household post-tax income is projected to fall sharply in 2022 and 2023, while consumption growth turns negative.”

BoE Governor Andrew Bailey told reporters: “The committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response.

“All options are on the table for our September meeting, and beyond that.”

REACTION:

Abrdn senior economist Luke Bartholomew: “In upping the pace of interest rate increases today, the Bank of England has become the latest in a string of international central banks to deliver historically large rate hikes.

“The Bank’s forecasts make clear just how difficult the UK’s economic picture is compared with other major countries.

“The Bank is simultaneously forecasting a long recession starting later this year and an even higher peak in inflation.

“This is a toxic economic combination, which would be difficult for the central bank to navigate at the best of times, let alone when it is increasingly being dragged into the political spotlight.

“With inflation now expected to stick around for longer, it is hard to see how the Bank can pivot towards supporting the economy any time sooner.

“As such, investors should expect further interest rate increases from here even as markets and the economy struggle.”

Kevin Brown, savings specialist at Scottish Friendly: “Today’s base rate rise will squeeze household incomes even tighter by pushing borrowing costs to their highest level since 2009, and the worst is still to come.

“Markets expect rates to increase to more than three per cent by next year and this is on top of inflation soaring well into double digits in 2023, exceeding the Monetary Policy Committee’s previous forecasts.

“Homeowners on a fixed rate mortgage are unlikely to be affected by any change in the bank rate, but for those with variable deals today’s 0.5% hike is going to make a considerable difference.

“The average variable rate is 2.77% according to UK Finance, so on a £250,000 loan over 25 years a 0.5% increase would add approximately £65 a month or nearly £779 a year.

“Plus, with the energy price cap set to rise again by at least £800 in October, the pressure on households is going to ratchet up. The net result will be people saving less and borrowing more to make ends meet.

“There are already signs that households have become more dependent on credit as the cost-of-living crisis has intensified.

“The latest figures from the Bank of England show the annual growth in credit card borrowing hit 12.5% in June, the highest level since November 2005.

“Coping with rising living costs while also paying more to borrow money, is going to make life particularly hard for those on lower incomes.

“Anyone still able to save should be encouraged to do so as rates are likely to rise, but be aware that if the gap to inflation widens, returns in real terms will continue to fall. The best way to combat that may be to consider investing some of your money.”

Paul Craig, portfolio manager at Quilter Investors: “The Bank of England has clearly decided that now is the right time to bring out more firepower and raise rates by 0.5% for the first time since 1995.

“It has clearly taken note of what the Federal Reserve is doing in the US and feels it could be running out of time to grapple inflation and get it under control.

“In the back of the mind of policy makers will be the current public mood.

“Sentiment is shifting against the Bank of England with a recent survey pointing to more people being dissatisfied with the job it is doing than satisfied people.

“Clearly inflation has been stickier than expected, but the BoE has been slow to act, preferring instead to raise rates incrementally. That time is now gone, especially with concerns inflation will peak at 12%.

“The other significant shift from the BoE in recent weeks was the dropping of mortgage affordability rules.

“With the economic picture looking incredibly challenging, and mortgage rates subsequently rising off the back of the BoE’s moves, the decision to drop those rules is looking more and more circumspect by the day.

“There is a concern the lessons of 2008 are beginning to be forgotten.

“The BoE will feel justified to be this aggressive given the strength of the jobs market, but the data is beginning to roll over.

“Jobs growth is weakening, PMIs are beginning to show businesses seeing slowdowns, while consumer savings are being depleted.

“This may be a silver lining for the BoE as with that inflation itself should begin to fall, but with the new energy price cap only a matter of months away, it won’t be long until rate cuts are back on the table to deal with sluggish and potentially negative economic growth.”

Nicholas Hyett, investment analyst, Wealth Club: “The Bank of England is playing catch up after some bumper rate rises from the ECB and Federal Reserve in the last month.

“The resulting rate hike may be the largest in nearly 30 years, but it was also widely expected, and the market reaction has been modest. Instead, the real focus today is on how much further the bank is willing to go as it seeks to bring inflation back down to its 2% target.

“The current inflationary spike is being driven by global food and energy prices, and higher interest rates in the UK will do little to alleviate those pressures. Stronger sterling has the potential to provide some relief.

“However, rising rates in the US and Europe mean the BoEs actions haven’t helped the pound much, and sterling is currently trading near its weakest level against the dollar in over 40 years.

“The risk now is that higher interest rates start to squeeze consumer and commercial borrowers too much, strangling the life out of the economy without significantly easing the cost-of-living crisis.

“Markets still think the Bank has a rate rise or two in the tank, but to some degree UK monetary policy is now caught in global forces over which the Bank has little control.

“Inflation will rise or fall according to what happens in Ukraine not Threadneedle Street, and rate decisions are dictated by moves at other central banks as much as by the MPC.”

Dr Tony Syme, macroeconomic expert from the University of Salford Business School:“Another month, another repeated message about the dangers of inflation, and another use of an inept tool to tackle it.

“Andrew Bailey today repeated his Mansion House speech when he said ‘there are no ifs or buts in our commitment to the 2% inflation target’.

“That means interest rates will exceed 2% this year and are very likely to exceed 4% next year, by which time inflation is expected to have reached 13%.

“In his Mansion House speech, he outlined the three big supply disturbances of the last year or so that has caused the inflationary rise: supply chain pressures post-Covid, a declining UK labour force, and the Russian invasion of Ukraine.

“None of these supply-side problems can be addressed by increases in interest rates. They are trying to carry water in a sieve. The intention may be reasonable, but the tools are wrong.

“And with no end in sight for the war in Ukraine, the current inflation is only going to worsen. The EU is already starting to ration gas and prepare for a tough winter.

“Through no fault of their own, people are already paying the cost of this inflation with the cost of living squeeze. This new rise in interest rates means that people will again suffer the consequences.

“The answer lies in international diplomacy and an end to the war in Ukraine, not interest rate rises.”

Zeeshan Syed, economic expert from the University of Salford Business School: “This was the right time that BoE raised the rate by 0.75% or even 1% because we needed a recession sooner rather than later.

“Although the rate rise is the biggest in decades; nevertheless, it’s nowhere near curtailing the supply-side price shocks. The inflation is bound to exacerbate further when we have a new prime minister with promises to spend more and tax less.

“Unfortunately, our cash-rich middle class, which accumulated substantial cash savings during the pandemic, is refusing to back down. Their refusal means that suppliers, service providers, and manufacturers can expect higher prices for their future services.

“This fallacy ensures a red-hot job market, an unwavering tendency to consume more, and rampant price growth. Just take this example, despite a more than 10% devaluation of GBP against USD, we are witnessing record demand for foreign holidays. Simple economics does not explain this behaviour.

“BoE’s job right now is not to shy away from the fact that any chance of prolonging this ‘consumption-led boom’ will make future recessions more painful, hurtful, and politically and socially unsustainable.”

Walid Koudmani, chief market analyst at financial brokerage XTB: “We saw investors sell out of their pound sterling positions in reaction to the UK’s biggest interest rate hike in 27 years.

“The hike itself was widely expected but the moods of GBP investors dampened from the negative rhetoric from the Bank of England itself on the UK’s economic outlook.

“The UK central bank expects the UK economy to shrink in the final quarter of this year and suffer from a recession for all of 2023. This marks a stark turn in their projections.

“The Bank of England is stuck in between a rock and a hard place. On the one hand, inflation is now expected to peak at 13%.

“This is far higher than recent projections and would normally force them to act faster to hike interest rates to curtail this cost pressure.

“Yet on the other hand, they expect UK economic activity to shrink and continue to do so for around the same time as the previous financial crisis.

“In that sense, they simply cannot move too far on rates or they will lock in a much deeper recession. A suspicious person might think ‘Are they trying to talk down inflation by warning about economic activity?’ Time will tell.

“The market does however continue to think the Bank of England moved too slowly on interest rates initially and now they are unable to chase their tail either due to the drop in UK economic activity.

“This doesn’t spell good news for the UK pound.”

About the Author

Mark McSherry
Dalriada Media LLC sites are edited by veteran news journalist Mark McSherry, a former staff editor and reporter with Reuters, Bloomberg and major newspapers including the South China Morning Post, London's Sunday Times and The Scotsman. McSherry's journalism has also appeared in The Washington Post, The Guardian, The Independent, The New York Times, London's Evening Standard and Forbes. McSherry is also a professor of journalism and communication arts in universities and colleges in New York City. Scottish-born McSherry has an MBA from the University of Edinburgh and a Certificate in Global Affairs from New York University.