Sterling plummets as Bank of England forecasts UK recession

Sterling fell by more than 2% against the dollar earlier today after the Bank of England raised interest rates and warned the UK could be heading for a recession this year.

The fall was close to the lows of March 2020, when the pound dropped to 1.15 USD at the height of the first lockdown, its lowest valuation since 1985.

As widely predicted, the Bank’s Monetary Policy Committee took the more cautious approach, hiking interest rates by 0.25 percentage points to 1%. While rates are still low, the latest increase is the highest level since the financial crisis in 2009. 

Six out of nine MPC members voted for the rise with three dissenters voting for a bigger increase of 0.5 percentage points.

The hike in interest rates comes as food and energy prices skyrocket, exacerbated by the war in Ukraine, prompting the Bank to up its inflation forecast to 10% by the end of the year.

The Bank’s revised forecast suggest that conomic growth is expected to fall nearly 1 per cent in the final quarter of 2022, remaining flat for 2023 and 2024. One of the reasons for sterling’s fall is that investors now take the view that the Bank will slow down the process of increasing interest rates because of worries that the economy is contracting. 

While the Bank’s Governor, Andrew Bailey, said the forecasts do not meet the technical definition of a  recession – two successive quarter of reduced GDP growth – he warned that the UK is heading for a sharp slodown in growth.

The UK economy is expected to shrink in the last three months of this year, with the MPC predicting that inflation will hit 10% by the end of the year – the highest since 1982 – after an expected rise in the energy price cap of up 40% in October.

In a more surprise moving,  the Bank also took a cautious approach to quantitative tightening, a move it said it would do once the bank rate reaches 1 %. It now says it will review the process and provide more details in August. 

Bailey added: “I recognise the hardship this will cause for many people in the UK, particularly those on the lowest incomes, often with little or no savings.”