Bank of England hikes, says UK may already be in recession

The Bank of England has warned that the UK will go into recession later this year. The expected recession is estimated to be the longest since the global financial crisis.

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LONDON – The Bank of England voted to raise its benchmark interest rate to 2.25% from 1[ads1].75% on Thursday, lower than the 0.75 percentage point increase expected by many traders.

Inflation in the UK eased slightly in August but remained at 9.9% year-on-year well above the Bank’s target of 2%. Energy and food have seen the biggest price increases, but core inflation, which strips out these components, remains at 6.3% year-on-year.

BOE now expects inflation to peak at just under 11% in October, down from a previous forecast of 13%.

The smaller-than-expected increase came as the bank said it believed the UK economy was already in recession, forecasting GDP to contract by 0.1% in the third quarter, down from an earlier forecast of 0.4% growth . This will follow a decrease of 0.1% in the second quarter.

Numerous analysts, along with the British Chambers of Commerce, have previously said they expect Britain to enter recession before the end of the year. In addition to energy price shocks, it faces trade bottlenecks due to Covid-19 and Brexit, falling consumer sentiment and falling retail sales.

The BOE cut its key interest rate, known as the bank rate, to 0.1% in March 2020 in an effort to support growth and spending at the onset of the coronavirus pandemic. But when inflation began to rise sharply late last year, it was among the first major central banks to start a hike cycle at their December meeting.

Seventh rise in a row

This is the seventh consecutive increase and takes UK interest rates to a level last seen in 2008.

In a release explaining its decision, the bank noted volatility in wholesale gas prices but said announcements of government caps on energy bills would limit further increases in consumer price index inflation. However, it said there had been further signs since August of “continued strength in domestically generated inflation.”

It added: “The labor market is tight and domestic cost and price pressures remain high [energy bill subsidy] reduces inflation in the short term, it also means that household consumption is likely to be less weak than projected in the August report over the first two years of the forecast period.”

Five members of its monetary policy committee voted in favor of the 0.5 percentage point increase, while three voted for a higher 0.75 percentage point increase that many had expected. One member voted for an increase of 0.25 percentage points.

The bank said it was not on a “preset trajectory” and would continue to assess data to determine the scale, pace and timing of future changes in Bank Rate. The committee also voted to start the sale of UK government bonds held in the Asset Purchase Facility shortly after the meeting and noted a “sharp rise in government bond yields globally.”

The bank’s decision comes against a backdrop of an increasingly weak British pound, recession forecasts, the European energy crisis and a program of new economic policies to be introduced by new Prime Minister Liz Truss.

Sterling hit new multi-decade lows against the dollar this week, trading below $1.14 through Wednesday and falling below $1.13 early Thursday. It has fallen sharply against the dollar this year and was last at this level in 1985. It was up 0.2% after the BOE decision with the 0.5 percentage point gain fully priced in.

The devaluation of the pound has been caused by a combination of strength in the dollar – as traders flock to the supposed safe-haven investment amid global market volatility and as the US central bank raises its own interest rates – and gloomy forecasts for the UK economy.

Mini budget Friday

Meanwhile, the country’s newly formed government has tabled a number of key economic policy proposals this month ahead of a “financial event”, dubbed a mini-budget, when they will be officially announced on Friday.

This is expected to include a reversal of the recent increase in national insurance tax, tax cuts for businesses and home buyers, and a plan for low-tax “investment zones”.

Truss has repeatedly stressed a commitment to cutting taxes in a bid to boost economic growth.

However, the energy crisis has also meant the government has announced a huge spending package to curb skyrocketing bills for households and businesses.

Data published on Wednesday showed that the British government borrowed 11.8 billion pounds ($13.3 billion) last month, almost double the forecast and 6.5 billion pounds more than the same month in 2019, due to a rise in public expenditure.

Britain is not alone in raising interest rates to fight inflation. The European Central Bank raised interest rates by 75 basis points earlier this month, while the Swiss central bank increased by 75 basis points on Thursday morning. The US central bank raised its benchmark interest rate range by the same amount on Wednesday.

“Critical Moment”

David Bharier, head of research at business group British Chambers of Commerce, said the bank faced a “difficult balancing act” in using the blunt instrument of rate rises to control inflation.

“The Bank’s decision to raise interest rates will increase the risk to individuals and organizations exposed to debt burdens and rising mortgage costs – dampening consumer confidence,” he said in a note.

“Recent energy price cap announcements will have provided some comfort to both businesses and households and should put downward pressure on the inflation rate.”

“The bank, which wants to curb consumer demand, and the government, which wants to boost growth, may now be pulling in opposite directions,” he added, saying an upcoming economic statement by the finance minister on Friday was a “critical moment.”

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