- Latest projections describe a “very challenging outlook” for the UK economy.
- BoE expects long recession and prolonged double-digit inflation
The Bank of England’s monetary policy committee (MPC) has voted to increase interest rates by 75 bps. The decision takes the UK Bank Rate to 3 per cent, and represents the steepest rate hike for over 30 years.
The move comes two weeks before the government is expected to announce a significant fiscal tightening package, and came alongside warnings from the Bank that the UK now faces a prolonged recession and spell of double-digit inflation.
Turbulent times
The six weeks since the last MPC meeting have been remarkably volatile. Former prime minister Liz Truss’s “mini” Budget represented the biggest round of tax cuts for 50 years, and triggered an extreme market reaction that saw sterling plunge and gilt yields soar. The Bank of England (BoE) was forced to stage emergency gilt market operations to restore financial stability, and temporarily suspended quantitative tightening (QT).
New prime minister Rishi Sunak has since pledged to “place economic stability and confidence at the heart” of the government’s agenda, and an autumn fiscal statement will be delivered on 17 November. Chancellor Jeremy Hunt is expected to unveil fiscal tightening measures totalling up to £50bn by 2026/7 - a move that would significantly dampen inflationary pressures in the UK, weakening the case for steep interest rate hikes.
This has introduced a significant degree of uncertainty to the MPC’s decision-making, and the BoE cautioned that there are “considerable uncertainties around the outlook”. Thursday’s report stressed that any changes to fiscal policy mooted for the 17 November autumn statement have not been taken into account.
Looking ahead
The BoE announcement comes hot on the heels of the US Federal Reserve's decision to raise interest rates for the fourth consecutive meeting on Wednesday. The Federal Funds target range now sits at 3.75-4 per cent, and there is speculation that the pace of hikes may start to slow as the Fed considers the “cumulative" impacts of these steep hikes.
The BoE recently argued that official rates may not have to rise as much as currently priced in by financial markets, and this rate hike decision was closely watched for signs of a policy pivot in the UK.
The Bank also reaffirmed its commitment to “take the actions necessary to return inflation to the 2 per cent target sustainably in the medium term”. The majority of the committee judged that further increases in Bank Rate may be required for a sustainable return of inflation to target, one member preferred a 0.5 percentage point increase, and one voted for a lower 0.25 percentage point rise.
After a brief hiatus, QT resumed on Tuesday. Gilt yields dipped following the auction, which Berenberg’s Kallum Pickering described as going “almost without a glitch”. Pickering argued that the BoE intends QT to happen “in the background”, leaving interest rates as the primary tool of monetary policy.
The MPC report stressed that although further rate hikes may be necessary, these could be to a “peak lower than priced into financial markets”, with 5.25 per cent the current peak forecast for late next year.
Growth and inflation
The monetary policy report stated that “the MPC’s latest projections describe a very challenging outlook for the UK economy”, and added that it is now expected to be in recession “for a prolonged period”.
The Bank’s latest forecasts suggest that CPI inflation will hit 10.9 per cent in Q4 of this year, before dropping back to 5 per cent by the end of 2023. The Bank expects the direct contribution of energy prices to CPI inflation to turn negative from Q2 2024 onwards, but based its forecasts on the assumption that some fiscal support for energy bills continues beyond the current six-month period of the Energy Price Guarantee (EPG).
The Bank’s forecasts suggest that the UK is now two months into a recession that is set to last until the first half of 2024, which would represent the longest continuous decline on record, though not the deepest.
Though the Bank’s growth and inflation forecasts paint a gloomy picture for the UK economy, it did caution that there are “considerable uncertainties around the outlook”, not least the future path of energy prices and fiscal policy changes announced in the autumn statement.
