August 15, 2022
The Bank of England has dealt a blow with its extremely disappointing outlook

The Bank of England on Thursday lived up to its promise to act “forcefully” to curb rising inflation, announcing the biggest increase in interest rates in more than a quarter of a century.

But while the rise in borrowing costs did not exceed analysts’ expectations, the central bank’s deeply dismal outlook on the immediate economic outlook came as a shock.

The pace of monetary tightening has accelerated despite BoE policymakers forecasting a recession in the early 1990s and the biggest drop in household income for more than 60 years.

BoE Governor Andrew Bailey argued that this painful squeeze on living standards was now inevitable and necessary in order to bring inflation under control and avoid a harsh economic downturn later.

Line chart of real GDP (Q4 of 2019 = 100) in which BoE forecasts five quarters of slowdown

“Inflation hits the hardest at least well. If we don’t act now . . . the consequences will be worse later,” he said after the BoE Monetary Policy Committee’s decision to raise interest rates by 0.5 percentage points to 1.75 percent. later said in a press conference.

He said that despite the “very uncomfortable situation” in which policymakers found themselves, “there is no if or but in our commitment to the 2 per cent inflation target”. Consumer price inflation hit a 40-year high of 9.4 per cent in June.

The major drop in the BoE’s growth forecasts is almost entirely due to a renewed spurt in bulk gas prices stemming from Russia’s supply embargo. Analysts said it could hit the UK economy harder than others in Europe, where governments have done more to protect consumers.

The BoE estimates that the annual fuel bill for a typical UK household could rise from £2,000 to around £3,500 now, when regulators reset their cap on prices in October – limiting consumer price inflation by 13 per cent by the end of the year. Double digits for most of 2023 by driving up and maintaining it.

“The outlook for immediate inflation is now so dire that the Monetary Policy Committee thinks it has no choice but to have a more severe economic slowdown,” said NatWest Markets economist Ross Walker.

Line chart of UK CPI inflation (%) with BOE forecasts showing double-digit inflation expected to last one year

But this near-term rise in inflation is not the main concern of policymakers – despite criticism at the BoE by some Conservative lawmakers for failing to act quickly enough to halt price hikes.

Policymakers said the rise in inflation was mainly due to global pressures which are already easing, commodity prices have eased and supply chains have started running more smoothly.

BoE deputy governor Ben Broadbent said the central bank could not have predicted the war in Ukraine and realistically countered its effects, even with “extraordinary insights”, such as Given the scale of the response needed to offset the unprecedented shock .

The MPC’s major concern is that inflation will remain above the BoE’s 2 percent target once these global pressures subside, if businesses and households become accustomed to rapidly rising prices and change their behavior as a result.

“We’ve seen things that worry us,” Bailey said, pointing to survey evidence that wage growth has accelerated since May, against a backdrop of ongoing labor shortages, while businesses have Still had the confidence to pass on the higher costs to consumers.

Bar chart (%) of forecasts for full years showing UK growth and inflation outlook, compares poorly with the rest of the G7

But the BoE thinks an impending recession will soon take the heat away from the labor market, with unemployment rising from the middle of next year to more than 6 percent by the middle of 2025.

Forecasts from the central bank suggest that inflation could fall below its 2 percent target by the end of 2024, even if energy prices remain in place for longer than the market currently expects and if the BoE does not take any further policy action, So the interest rates will remain stable at the new level. of 1.75 percent.

Bailey said the uncertainty about these forecasts was exceptionally high, especially when it comes to energy prices, and made it clear that the BoE’s aggressive action on Thursday should not be taken as a sign that it Will now start fast pre-determined series. rate increases.

“Policy isn’t on a predetermined path, and what we do this time doesn’t tell you what we’re going to do next time,” he said. “Our September meeting and beyond are all options on the table.”

The BoE plans to make a move in September to begin monthly sales of £875bn of assets pooled under its quantitative easing programs – a stable settlement aimed at reducing the stock by around £80bn in the first 12 months with. But the BoE made it clear that interest rates will remain its main tool for adjusting monetary policy.

Chart showing how the UK recession forecast compares to previous recessions - Cumulative % change in GDP from pre-recession peak

Analysts said the BoE’s forecasts suggest a longer-term reduction in interest rates may be needed, even though the MPC considers policy tightening necessary in the near term to bring inflation under control.

Paul Dales at consultancy Capital Economics said, “Overall the bank is forecasting stagflation and suggesting that in the near term, medicine is the tough love of higher interest rates and the comfort blanket of further interest rate cuts may be needed.” Is.”

But Investec’s economist Sandra Horsfield noted that the BoE’s forecasts did not factor in any fiscal stimulus proposed by both candidates for Conservative Party leadership – and that tax cuts, or other political alternatives, “materially” approach. can affect.

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