The Bank of England raised interest rates by the most since 1989 to fight inflation
Bank of England policymakers raised interest rates by the biggest amount since 1989 on Thursday, intensifying the fight against inflation, even as the central bank predicted the British economy would enter a “prolonged” recession.
The bank raised its key policy rate by three-quarters of a point, stepping up its efforts to tighten financial conditions, to 3 percent, the highest since November 2008.
It was the first meeting since Liz Truss’ short and turbulent premiership came to an abrupt end two weeks ago, sending shockwaves through financial markets.
With all the turmoil in Britain over the past few months, high inflation, along with the risk of a longer-than-expected stay, remains a constant scourge for the central bank. Annual inflation topped 10 percent in September, the highest in four decades and five times the central bank’s target.
Bank officials have said they are determined to bring inflation down to the 2 percent target and will use higher interest rates to do so. But they also sent a clear message to financial markets that the bank is unlikely to raise interest rates as high as traders had expected, which was around 5.2 percent when the bank set its forecast in late October.
The Bank of England expects inflation to rise to around 11 percent this year, less than it had previously forecast, as the government plans to freeze home energy bills. While the freeze keeps headline inflation in check, it could add to price pressures coming from other goods and services as households are forced to spend less on their energy bills, the bank said.
Inflation is expected to hover around 10 percent early next year before falling sharply as global inflationary forces such as energy costs and supply chain bottlenecks ease.
The bank’s latest forecasts “portrayed a very difficult outlook for the UK economy”, politicians said, according to minutes of their meeting this week. “It was expected to be in a prolonged recession.”
Government bonds extended their slide after the announcement and the pound fell against the dollar, tightening moves that began in response to the Federal Reserve’s rate hike late Wednesday. Britain’s 10-year government bond yield rose 10 basis points to around 3.5 percent. The British pound fell 2 percent in intraday trading.
Barely recovering from the pandemic, Britain’s economic growth is again faltering as rising energy rents, food costs and mortgage rates squeeze consumer spending, stalling one of the main engines of the country’s economy.
The bank forecast the economy would contract by 0.75 percent in the second half of 2022 and continue to decline next year and into the first half of 2024 due to higher energy prices and “substantially” tighter financial conditions, including higher home mortgage rates and borrowing. costs for companies. This two-year decline is based on the assumption that the central bank is raising interest rates in line with market expectations. While the bank scaled back those expectations, it said that even if interest rates do not rise again, the economy will still be in recession for the second half of this year and most of next year.
This outlook could moderate how high the bank raises interest rates. This is because it takes time for exchange rate changes to affect the economy, and the impact is most likely to hit Britain when it is in recession, when households and businesses are least able to bear the extra economic pain.
The delay is a challenge for many central banks, which are also rapidly raising interest rates amid the highest inflation in decades and potential recessions. on wednesday Federal Reserve raised interest rates by three-quarters of a percent and signaled that more hikes were on the way, albeit at a slower pace. Last week that European Central Bank raised interest rates by three-quarters of a point as it said inflation could pick up, but the bank heavily emphasized that the economy was weakening.
There have been “significant developments” in fiscal policy in the UK since the bank’s last policy meeting six weeks ago, it said in a statement on Thursday. The day after the previous meeting, on September 23, Ms Truss’ finance minister, Kwasi Kwarteng, announced a series of unfunded tax cuts that sent the government bond market into turmoil and put Britain’s fiscal policy on a collision course with the bank’s monetary system. politics.
At the time, the central bank said it needed a “significant” response as it expected the tax cuts and spending plan to add to inflationary pressures. Meanwhile, in another corner of the bank, officials intervened in the bond market, fearing for the country’s financial stability.
Ms Truss resigned two weeks ago and her successor, Rishi Sunak, made it clear he intended to take a different approach to public finances. Later this month, he and Chancellor of the Exchequer Jeremy Hunt are expected to announce tax hikes and spending cuts alongside a plan to reduce Britain’s debt levels.
However, the bank said on Thursday that the fiscal measures announced so far, including a freeze on energy bills, the scrapping of health and social care tax and a tax cut on house purchases, would boost demand more than the bank had forecast three months ago.
Seven of the bank’s nine-member rate-setting committee, including governor Andrew Bailey, voted in favor of a three-quarter point rate hike. The other two voted for a hike of half and a quarter point each, arguing that the cost-of-living crisis warranted caution against too much tightening and that monetary policy was already restrictive.
Britain’s outlook remains bleak and uncertain. The program to freeze energy bills, which took effect last month and is helping to keep overall inflation in check, will only be in place until the end of March. Even by this measure, average energy bills are nearly twice as high as last winter, food inflation is at its highest in four decades, and many households are facing a sharp rise in their mortgage payments. As customers aim to cut costs, corporations are warning of lower profits, and many companies and services are facing disruption from ongoing labor disputes. Meanwhile, the labor market remains tight, with more people out of work than expected, including due to long-term illness.
Overall, the bank forecast that household income, after taxes and inflation, would fall by 0.25 percent this year and 1.5 percent next year.
Among the reasons for concern are rising mortgage payments. Around 30 per cent of UK households have a mortgage, and although the majority of these are fixed-rate, they tend to have short terms, such as two and five years. The bank said a quarter of mortgages – just over two million – are set to reach the end of their fixed term by the end of next year, which will “significantly” raise mortgage costs for those households.
A squeeze on incomes from higher inflation and higher mortgage rates “is expected to weigh on household spending for some time,” the bank said. “Despite fiscal support, energy price shock remains significant.”
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