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

The Bank of England raised interest rates by 0.5 percentage point on Thursday.

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LONDON — The Bank of England voted Thursday to raise the key rate from 1.75% to 2.25%, lower than the 0.75 percentage point rise many traders had expected.

Inflation in the UK declined slightly in August but remained well above the bank’s target of 2% at 9.9% year-on-year. Energy and food have seen the biggest price increases, but core inflation, which excludes these components, is still at 6.3% yoy.

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

The rise was smaller than expected when the bank said it believed the UK economy was already in recession as it forecast GDP to contract 0.1% in the third quarter, down from an earlier forecast of 0.4% growth. It would follow a 0.1% decline in the second quarter.

Numerous analysts, along with the British trade association the British Chambers of Commerce, have previously said they expect the UK to plunge into recession before the end of the year. In addition to energy price shocks, it faces trade bottlenecks from Covid-19 and Brexit, declining consumer confidence and declining retail sales.

The BOE cut its key rate, also known as the bank rate, to 0.1% in March 2020 in an effort to support growth and spending amid the outbreak of the coronavirus pandemic. However, when inflation rose sharply late last year, it was one of the first major central banks to kick off a walking cycle at its December meeting.

Seventh Consecutive Rise

This is the seventh consecutive increase and brings UK interest rates to levels last seen in 2008.

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

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

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Five members of the Monetary Policy Committee voted for 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 point.

The bank said it was not on a “predetermined path” and would continue to review data to determine the magnitude, pace and timing of future changes in bank interest rates. The committee also voted shortly after the meeting to begin selling UK government bonds held in its asset purchase facility, noting a “strong rise in government bond yields worldwide”.

The bank’s decision comes against the background of a weakening 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 plunging below $1.13 early Thursday. It has fallen sharply against the dollar this year and was last at this level in 1985. It rose 0.2% after the BOE decision, with the 0.5 percentage point gain fully priced in.

The pound’s devaluation has been driven by a combination of strength in the dollar – as traders flock to the alleged safe-haven investments amid global market volatility and as the US Federal Reserve raises its own interest rates – and grim forecasts for the UK. economy.

Mini budget Friday

Meanwhile, the country’s newly formed government made a host of important economic policy proposals this month ahead of a “fiscal event” called a mini-budget, which will be officially announced on Friday.

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

Truss has repeatedly emphasized the drive to cut taxes to boost economic growth.

However, the energy crisis has also led the government to announce a massive spending package to curb skyrocketing bills for households and businesses.

Data released on Wednesday shows that the UK government borrowed £11.8 billion ($13.3 billion) last month, almost twice as much as forecast and £6.5 billion more than the same month in 2019, as a result of an increase of government spending.

‘Critical moment’

David Bharier, head of research at business group the British Chambers of Commerce, said the bank was facing a “tough balancing act” in using the blunt tool of rate hikes to manage inflation.

“The bank’s decision to raise interest rates will increase the risk for 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 businesses and households alike and should put downward pressure on inflation.”

“The bank, which wants to dampen consumer demand, and the government, which wants to increase growth, could now move in opposite directions,” he added, saying the forthcoming economic statement from the finance minister on Friday was a “critical moment”.

Samuel Tombs, UK chief economist at Pantheon Macroeconomics, said the bank was rising at a “sensible pace” given the lower inflation outlook and the emerging slowdown in the economy.

Tombs forecast a 50 basis point increase at the bank’s November meeting, with risks pointing to a 75 basis point increase given the hawkishness of three committee members. He said this would likely be followed by a 25 basis point increase in December, bringing bank interest rates to 3% by year-end, with no further hikes next year.

The UK 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 Switzerland’s central bank raised 75 basis points on Thursday morning. The US Federal Reserve increased the bandwidth by the same amount on Wednesday.

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