Bank of England: recession won’t be as bad as feared

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The impending UK recession will be shorter and shallower than previously feared, according to an encouraging new forecast by the Bank of England, which hiked interest rates to a 15-year high of 4% today, writes Mattie Brignal.

The Bank’s Monetary Policy Committee voted 7-2 in favour of upping the base rate by 0.5 points – its tenth consecutive rate rise. The European Central Bank and the US Fed also opted for rate increases in the last 24 hours, of 0.5 and 0.25 points, respectively.

While expected, the Bank’s decision will be a blow to the roughly one third of households that have a mortgage. It means those on a typical tracker mortgage will pay about £49 more a month, while households on a standard variable rate face a £31 jump.

The good news is that the usually gloomy Bank is more optimistic than it was about the state of the economy. It upgraded its 2023 growth forecast by a full percentage point – from -1.5% to -0.5%.

Even though UK GDP is forecast to remain lower than 2019 levels until 2026, the recession is now expected to last just over a year rather than almost two, as energy bills fall and price rises slow.

Paul Johnson, director of the Institute for Fiscal Studies (IFS) think tank, said the Bank’s forecast is “a big change in a positive direction”, adding that it will give Jeremy Hunt “more room for manoeuvre” in his 15 March Budget.

Even so, the Chancellor is for the moment holding firm against the fiscal hawks – including many of his own MPs – who think now is the time to spend more and tax less.

Hunt made clear today this wasn’t on the cards. He called inflation “a stealth tax that is the biggest threat to living standards in a generation”, and insisted he would “[resist] the urge right now to fund additional spending or tax cuts through borrowing, which will only add fuel to the inflation fire and prolong the pain for everyone.” He said he wanted to ensure the government was in “lock step” with the Bank’s approach.

Whether it’s the right approach remains to be seen. Today’s rate hike certainly came as a disappointment to those who think growth is now a bigger problem than inflation. Dr Andrew Lilico, Chairman of the Shadow Monetary Policy Committee and Fellow at the Institute of Economic Affairs, warned that the Bank risks monetary overkill if it carries on tightening. “The Bank was too slow to raise rates initially, but it must beware of oversteering now in response to its initial error,” he said.

Two of the MPC’s nine members voted to keep base rate at 3.5% over fears the economy is weakening and a belief that the delayed impact of rate rises will already have done enough to drag inflation down to around the 2% target. The UK’s consumer prices index (CPI) inflation rate dipped slightly to 10.5% in December, down from 10.7% in November and 11.1% in October.

Despite this, Andrew Bailey said it was too soon to “declare victory” over inflation, warning that monetary tightening may have to continue for longer if pay keeps rising sharply. In its report, the Bank suggested it was largely ignoring the predicted fall in inflation because it was more important to ward off the risk that “domestic wage and price pressures remain elevated” by raising interest rates now.

And yet, markets are lowering their expectations of future peak rates. Analysts now think rates will reach a maximum of 4.25 per cent in the summer, down from December forecasts of over 5 per cent. While rates are still rising for the moment, the end is in sight.

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