The Bank of England announced on Thursday that they are raising interest rates by 75 basis points, the largest single hike since 1989. They also warned that a deep recession may be coming and that policymakers will need to do more to temper market expectations for additional tightening.
A 75 basis point increase in the Bank Rate brings the main lending rate to 3%. This is the eighth consecutive hike to the rate since it was the last cut 12 months ago.
Nonetheless, the Bank of England seemed to agree with the marketplace’s belief that future interest rate hikes would be higher than anticipated.
Affirming some of the less-than-specific guidance it is known for, the Bank of England’s Monetary Policy Committee has announced that it would likely raise interest rates if UK economic conditions progress broadly in line with the MPC’s latest projections.
However, such an increase to other than a previously announced level may come as a surprise given the Bank’s lack of previous commitment; the inflationary effect of Brexit is widely expected to be short-lived and not necessarily produce a long recession.
The MPC has updated projections for economic growth and inflation and remarked that the outlook is looking very challenging. The goal is to get inflation back to the 2% target, but they need to catch up.
The UK’s GDP is expected to shrink by around 0.75% over the second half of 2022 — a trend that can be largely attributed to consumers feeling the squeeze from increasing energy and tradable goods & services prices.
The Bank also expects no growth in labor productivity and a decrease in business investment, both caused by the prolonged period of recession and an even worse economic performance.
Economic growth is expected to continue declining through 2024 because of higher energy prices and tighter financial conditions. This would be the longest recession since comparable records began. The unemployment rate is projected to rise to 6.5 by 2025.
After a change in government, many economists expected the central bank to take on a less hawkish tone. The new Prime Minister Rishi Sunak is likely to return to a more classical fiscal policy after the brief and mismanaged tenure of predecessor Liz Truss.
This means monetary as well as the fiscal policy will no longer be pulling in opposite directions. Moreover, the Federal Reserve unanimously voted to further increase its interest rates on Wednesday, bringing its target range for short-term borrowing rates to 3.75%-4%. This will be the highest since 2008.
After the ECB implemented a 75 basis point hike on their main benchmark last week, it now stands at 1.5%. This is its highest level since 2009.
Andrew Bailey, Governor of the Bank of England, made it clear while he was speaking at a recent press conference that “the projections based on the market’s assumed path of interest rates serve as a reminder that we should not increase interest rates too much.”