Bailey hints recession worth the price

The Bank of England brought out its big bazooka today, hiking interest rates higher than expected with half of a percentage point rise to five per cent –  the thirteenth rise in a row and a number that will prove unlucky for many.

Although the Bank’s Monetary Policy Committee had been predicted to opt for 0.25 of a percentage point, the majority of members chose to walk the high wire, taking rates to a 15 year high. 

MPC members explained the bigger rise was due to persistent inflation which is taking longer to unwind than expected. They were referring to May’s inflation figures which showed that price rises are staying sticky, with core inflation actually rising because of wage increases in a tight labour market. 

But not all members agreed. Two of the nine-member committee voted to hold rates at 4.5 per cent, arguing that much of the impact of past tightening has yet to be felt through the wider economy and that inflation is on its way down. They include Professor Silvana Tenreyro whose views you can find here.

Also taking the more critical line is economist Julian Jessop who said a more credible bank could have held rates. Instead, he says, the Bank had to go for overkill because confidence in its credibility is low after so many other errors. However, there is an upside which is that the costs of two-year and five-year mortgages depend on where interest rates will be over the life of the deal – not just on the current rate. 

Others fear the latest hike is a big mistake, one which will cause more misery for thousands of mortgage holders – particularly for those on fixed-rate deals – and force businesses to put off investment, potentially pushing the country into recession. 

Indeed one of the Treasury’s own economic advisers has warned that the Bank might have to create a recession as the only way to curb inflation. 

At a post-MPC press conference, Andrew Bailey, the Bank’s governor, denied this is the case but it came with a heavy caveat. “We are not expecting, we are not desiring recession but we will do what is necessary to bring inflation down to target.” He also warned that workers should lay off asking for wage increases while businesses should refrain from bolstering profit margins. It’s a tall order.  

Yet Rishi Sunak and Jeremy Hunt both supported Bailey’s bazooka approach, despite the misgivings of many Tory MPs who are in despair over the mortgage meltdown and the danger of a slow-down in growth. They have reason to be worried: the latest YouGov poll for Times Radio shows the Tories are even losing support in their traditional rural heartlands to Labour. 

Speaking at an event in Kent, Sunak – who made halving inflation one of his famous five pledges – called on the government to “hold our nerve”. He added that getting inflation down was never going to be easy, but is still the right priority for everyone, saying: “I’m here to tell you that I am totally 100% on it, and it is going to be okay, and we are going to get through this.”

The financial markets are not so sure, with gilt yields rising again after the hike. Traders are now pricing in interest rates of 6% by December. Stock markets in the UK, across Europe and the US were all rattled by worries of more rate rises to come. In testimony to the House of Representatives on Wednesday, the US Federal Reserve chairman, Jay Powell, warned that further hikes will be needed to bring inflation down to the two per cent target. The pain is not over yet. 

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