The government is facing calls to launch a fresh package of emergency financial support for households after the Bank of England warned Britain’s economy could plunge into recession before the end of the year.
As the nation went to the polls in the local elections, the Bank raised interest rates from 0.75% to 1% to tackle spiralling inflation made worse by Russia’s war in Ukraine. With a fresh jump in home energy bills expected in October, it forecast inflation would rise above 10% this year, the highest level since 1982.
The rate rise brings borrowing costs to levels unseen since the recession caused by the 2008 financial crisis, but the Bank’s monetary policy committee (MPC) said action was warranted despite the gathering economic storm clouds.
Andrew Bailey, the Bank’s governor, said there was a “narrow path” the central bank had to navigate between the dual risks of inflation and recession facing the British economy. He said the inflation shock had been made worse by the impact on supply chains from Covid lockdowns in China and the rise in energy costs since Vladimir Putin’s invasion.
UK inflation is forecast to peak above 10% in the fourth quarter of 2022
“I recognise the hardship this will cause for many people in the UK, particularly those on the lowest incomes, often with little or no savings, who are hit hardest by increases in the prices of basic necessities like food and energy,” Bailey said.
The pound fell sharply after the rate decision as the City reacted to Britain’s weaker economic prospects. Sterling tumbled by almost 3 cents against the dollar on the currency markets and by more than a cent against the euro.
With the Conservatives facing a difficult night in the polls, Labour and opposition parties called on the government to drastically rethink its support measures for hard-pressed families as the cost of living crisis escalates further.
Rachel Reeves, the shadow chancellor, said the government was out of ideas and out of touch. “Not only are ministers shrugging their shoulders at the spiralling cost of living crisis, they’ve made it worse by hitting working people and businesses with 15 Tory tax rises that will further stifle our economic growth.”
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Calls were growing on Thursday for the government to launch a windfall tax on oil and gas companies to fund measures to help struggling families, after the energy giant Shell reported a record quarterly profit of $9bn (£7.3bn). It came after BP posted its highest quarterly profit in more than a decade on Tuesday.
“With a one-off windfall tax on oil and gas producer profits, we can cut household bills by up to £600 and support businesses through the cost of living storm,” Reeves said.
In a downbeat assessment, the Bank said British households were likely to suffer the second biggest squeeze on their incomes since records began in 1964. Amid a surge in global gas prices after Putin’s invasion, it forecast energy bills were set to rise by 40% in October on top of last month’s record 54% increase.
Economists at the Resolution Foundation said the Bank’s projections showed the average household in Britain would lose about £1,200 this year from the cost of living squeeze, laying the ground for a weaker period of growth ahead as families rein in their spending.
The MPC said inflation would probably peak above 10% after the increase in the Ofgem energy price cap expected in October, in a development that would push gross domestic product (GDP) into reverse in the fourth quarter.
Although a modest recovery is expected at the start of next year, ensuring two consecutive quarters of falling GDP (the technical definition of a recession) is likely to be avoided, the Bank warned Britain’s economy would shrink by 0.25% over the course of 2023 as a whole, in effect a slow-burn recession. “It is a very obviously sharp slowdown in activity,” Bailey said.
Annual GDP growth graphic
Predicting a grim economic backdrop before the next general election, the Bank said the hit to living standards and weaker growth would cause a sharp rise in unemployment to 5.5%, surpassing the jobless rate during the early stage of the Covid pandemic.
However, the MPC judged that the risks from high inflation becoming a persistent feature of the UK economy warranted immediate action. With the inflation rate forecast to hit five times the Bank’s official target of 2%, three members of the MPC – Jonathan Haskel, Michael Saunders and Catherine Mann – voted for a larger half percentage point rise in borrowing costs in a 6-3 split on the rate-setting committee.
The US Federal Reserve raised interest rates by 0.5 percentage points on Wednesday, the biggest single increase since the turn of the millennium, in order to combat surging prices.
Financial markets had anticipated the Bank would raise interest rates to as high as 2.5% next year. Basing its economic forecasts on this judgment, the Bank said inflation would probably fall back close to its target rate within two years and would drop to just 1.3% within three.
With the economy faltering, analysts said this signalled the Bank was unlikely to increase rates much further, while two members of the MPC signalled in the minutes of its meeting that such steps were “not appropriate” given the economic risks.
The committee also decided to hold back from actively selling its £875bn portfolio of UK government bonds built up through its quantitative easing programme started in the 2008 financial crisis. It had previously signalled that interest rates rising to 1% would open the door for disposals. The MPC said it had asked a team at the Bank to draw up plans for a disposal programme and would provide an update in August.
A Treasury spokesperson said it recognised the Bank’s forecasts would be concerning for many people, and it was providing £22bn of support for families this year to help with the cost of living. “The UK is not alone in these challenges and while we can’t shield everyone entirely, we are taking action to ease pressures on households and drive growth,” they said.
