The Bank of England hiked interest rates by the most in 27 years on Thursday as it predicted U.K. inflation may hit double digits by the end of 2022 and the economy could endure more than a year of recession as high prices hit households partly as a result of the war in Ukraine.
The 50 basis point hike in borrowing costs by the BoE’s monetary policy committee (MPC) was the biggest increase since 1995, and took interest rates to 1.75%, the highest level since the depths of the financial crisis in 2008.
Inflationary pressures in the U.K. and the rest of Europe have intensified significantly since its May monetary policy meeting said the BoE: “That largely reflects a near doubling in wholesale gas prices since May, owing to restriction of gas supplies to Europe and the risk of further curbs. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for U.K. households and further increase U.K. CPI in the near term.”
The typical annual household fuel bill could rise from just under £2,000 to around £3,500 when regulated prices rise in October, the BoE said.
U.K. inflation hit 9.4% in June amid surging energy and food prices. Factory gate prices in June rose at a 45-year high of 16.5%, the fastest pace in 45 years and a sign of potentially higher consumer prices in the pipeline.
The BoE said it expected consumer price inflation to hit 13% in the fourth quarter of the year and remain “at very elevated levels” for much of 2023 before dropping back to its 2% target in two years time.
As wages rise at half the pace of inflation, real household income will fall sharply in 2022 and 2023, with consumption contracting as a result, said the BoE. This would tip the U.K. into a recession by the end of the year, a downturn that may last five quarters.
The BoE’s downbeat assessment of the U.K.’s economic prospects hit sterling GBPUSD, -0.55%, which fell 0.5% to $1.2093, and pushed benchmark 10-year gilt yields TMBMKGB-10Y, 1.824% down 7.5 basis points to 1.836%.
Analysts noted that comments from BoE governor Andrew Bailey suggested he did not want the market to think 50 basis point rate hikes were now the norm.
“The MPC’s new line that ‘policy is not on a pre-set path’ suggests that it is uncomfortable with markets’ pricing for 50bp hikes at the next two meetings,” said Samuel Tombs, chief U.K. economist at Pantheon Economics.
“Indeed, the MPC’s new baseline forecasts—based on energy prices holding steady after following futures curves for the next six months, and interest rates following the path expected by markets—imply that it is nearing the end of its rate hiking cycle,” Tombs added.
The BoE’s tightening move is the latest among developed-economy central banks as they strive to control inflation running at multi-decade highs. The European Central Bank last month raised interest rates to zero after many years in negative territory, and in the U.S. the Federal Reserve has swiftly increased borrowing costs by 250 basis points since March.
Such monetary tightening is likely to slow economic activity, observers warn. 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.