The Bank of England upgraded its UK growth forecast by the highest amount on record today, scrapping its gloomier February prediction of recession this year even as it warned of higher-than-expected inflation in the coming months.

The Bank’s policymakers now expect the economy to expand over the next two years rather than shrink, and admitted that growth would be “materially stronger”. The economy is now expected to be a full 2.25% larger in three years’ time than previously thought.

While the updated figures still anticipate relatively sluggish growth this year and next, it’s a dramatic change from doom-laden warnings of the longest recession in modern British history made just a few months ago. Indeed, many economists are questioning how the Bank’s forecasters could have got their predictions so badly wrong. 

However, the rosier growth forecast accompanied bad news for mortgage borrowers, as the Bank upped the cost of borrowing to a 15-year high of 4.5%, its twelfth consecutive interest rate rise.

The fact the 0.25-point hike was widely anticipated won’t make it any easier for millions of borrowers whose fixed-rate mortgages come up for renewal this year, and millions more on variable rate deals. 

The Bank warned that only a third of the impact of its previous 11 rate rises had passed through to borrowers because most of the 8m homeowners with mortgages had fixed-rate loans that had not yet come up for renewal.

Driving the latest rate hike is an inflation rate that remains stubbornly high (10.1% in March). The Bank now believes inflation will average just above 5% by the end of this year, instead of 3.9%, with “significant” risks that the rate could be higher. “Almost all” of recent inflation, the Bank said, was being driven by soaring food and goods prices, which it expected to continue. This leaves Rishi Sunak with a minute amount of wiggle room on his promise to halve inflation by the end of the year.

The Bank’s governor, Andrew Bailey, refused to give any hint at what the Monetary Policy Committee is thinking about the future path of interest rates, but market sentiment is that they may well have peaked.

Josie Anderson, an economist at the CEBR, says she expects this latest increase to be the last for the time being. Factors motivating a pause in monetary tightening, she says, are “the risk of recession in the UK resulting from high rates, the expectation of a deceleration in inflation over the rest of the year, as well as the current financial sector turmoil.”

Anna Leach, deputy chairman of the CBI, was more cautious, saying the direction of interest rates remained “uncertain”. She warned that “inflation could surprise to the upside, particularly if wage rises remain elevated, suggesting further rate rises.”

The most immediate test of the Bank’s forecasting skills – and the best indication of further interest rate hikes on the horizon – will be whether inflation “falls sharply from April,” as it predicts. Fingers crossed. 

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