LONDON (AP) — The Bank of England projected Thursday that the United Kingdom’s economy would enter a recession at the end of the year and hiked interest rates by the largest amount in more than 27 years, pushing to tame accelerating inflation driven by the fallout from Russia’s invasion of Ukraine.
The rate hike of three-quarters of a point pushes the bank’s key interest rate to 1.75%, the highest since the depths of the global financial crisis in December 2008. Most economists expected the hike after Gov. Andrew Bailey said two weeks ago that the United Kingdom’s central bank would “act forcefully” if the inflation picture worsened.
And worsen it will. Inflation will accelerate to over 13% in the final three months of the year and remain “very elevated” for much of 2023, the bank said. The forecast reflects a sharp increase from the 40-year high of 9.4% recorded in June.
The bank’s forecasters say inflation will hit its highest point for more than 42 years amid the doubling of wholesale natural gas prices tied to the war. Those energy prices will push the economy into a five-quarter recession - with gross domestic product shrinking each quarter in 2023.
“Growth thereafter is very weak by historical standards,” the bank said.
Central banks worldwide are struggling to control surging inflation without tipping economies into recession that were just beginning to recover from the coronavirus pandemic. Higher interest rates raise borrowing costs for consumers, businesses and the government, which tends to reduce spending and ease rising prices. But such moves are also likely to slow economic growth.
The U.S. Federal Reserve has moved aggressively, increasing its key rate by three-quarters of a point in each of the past two months to a range of 2.25% to 2.5%. The European Central Bank’s first increase in 11 years was a larger-than-expected half-point hike last month to tame record inflation.
The International Monetary Fund last week cut its outlook for global economic growth, citing higher-than-expected inflation, continuing COVID-19 outbreaks in China and further effects from the war in Ukraine. The U.K. economy is likely to expand just 0.5% next year, the slowest growth rate among the world’s advanced economies, the IMF said.
The landscape is especially complicated for central banks because many of the factors driving inflation are beyond their control, particularly food and energy prices that have soared due to uncertainty surrounding Russia’s invasion.
But those external pressures are now becoming embedded in the U.K. economy, with public- and private-sector workers demanding wage increases to prevent inflation from eroding their living standards.
“This explains why at the MPC’s last meeting we adopted language which made clear that if we see signs of greater persistence of inflation, and price and wage setting would be such signs, we will have to act forcefully,” Bailey said in speech last month.
The last time the U.K. approved a similar rate increase was December 1994, when interest rate decisions were still made by the government’s treasury chief in consultation with the central bank governor.
The Bank of England predicted that inflation will reach over 13% in the final three months of the year and remain “very elevated” for much of 2023.
“With gas prices continuing to reach record levels, both households and businesses will see large increases in their energy bills throughout the winter and into 2023,” said Jack Leslie, senior economist at the Resolution Foundation, a think tank focused on the living standards of low- and middle-income families. “How long this high inflation will last is hugely uncertain, but the cost-of-living crisis looks set to last longer and hit households harder than previously anticipated.”
But even with all the pressure for a big increase in interest rates, some economists think the Bank of England will remain cautious as it seeks to protect economic growth.
Dean Turner, an economist at UBS Global Wealth Management, said he is sure the bank will raise rates, just not by how much.
“What is a central banker to do?” he asked. “Should they be prioritizing current inflation, most of which is driven by factors beyond the control of the Bank of England, or the faltering growth backdrop? I do not envy them.”
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