LONDON (CN) — The United Kingdom’s central bank, the Bank of England, increased the bank rate of interest by 0.5% on Thursday - the highest rate hike in 27 years – while issuing a foreboding forecast for the country’s economy.
The bank is predicting a deep recession of at least five quarters – a contraction that would last until 2024 – amid inflation that is expected to reach a high of 13% and remain in double figures for at least the next 21 months.
At five quarters, the predicted recession would tie for the longest the U.K. has ever experienced, whilst 13% inflation is the highest in 42 years. As a result, in an 8-1 vote of the bank’s Monetary Policy Committee, the decision was taken to raise interest rates to 1.75%. The bank has said it does not expect inflation to return to its 2% target rate until 2024 at the earliest.
Speaking at a press conference announcing the change, Bank of England Governor Andrew Bailey said: “The committee judged that a more forceful policy action was justified at this meeting, as there have been some indications that inflationary pressures are becoming more persistent and broadening to more domestically driven sectors. Companies are finding it easier to increase prices, and the labor market remains tight.”
“Overall, a faster pace of policy tightening at this meeting,” Bailey added, “will reduce the risks of a more extended and costly tightening cycle later.”
The ominous forecast comes amid a worsening cost-of-living crisis, primarily driven by a huge spike in energy costs. Average household energy bills are already up 54% from this time last year and are expected to rise by a further 70% in October, with more rises in January next year. Experts are concerned that the rises will push as many as a third of Brits into fuel poverty, in which they spend more than 10% of their income on energy.
The bank may be hoping that suppressing demand through a rate increase will stem growing inflation. But amplifying recessionary forces with monetary policy is a risky move, and more than anything else signifies the limited tools available to the bank to deal with what is essentially a supply-side shock.
The rate hike is expected to have a big impact on mortgages in the U.K. Around 2 million homeowners may be subject to higher borrowing costs as a result, which threatens to worsen already tight household budgets.
The stark forecast comes amid the ongoing Conservative Party leadership contest, the winner of which will become the country’s next prime minister. Both contenders, former Chancellor Rishi Sunak and Foreign Secretary Liz Truss, were taking part in televised hustings on Thursday evening, just after the forecast was released.
Truss, the contest’s frontrunner, has made tax cuts central to her campaign, and reiterated her planned tax reductions in response to the economic predictions. She intends to reduce duties, income taxes and corporation taxes if she becomes prime minister, in order to boost competitiveness and encourage economic growth.
Attacking her rival Sunak’s planned tax hikes, Truss said: “To say that we’re going to put up taxes to the highest level in 40 years, and say that’s going to help economic growth, I think that’s wrong.” She insisted the that the recession predicted by the central bank was “not inevitable.”
A hole of 8.8 billion pounds ($10.6 billion) in Truss’s spending plans have led to suggestions that she would fund tax cuts through increased borrowing. This was highlighted by her opponent, who said that borrowing would inflame inflationary pressures.
“Increasing borrowing will put upward pressure on interest rates, which will mean increased payments on people’s mortgages. It will also make high inflation and high prices last for longer, making everyone poorer," Sunak said.
“It’s not the tax burden that is causing inflation," he added. “I’m worried that Liz Truss’s plans will make the situation worse.”
The Bank of England has also found itself dragged into the leadership contest. Truss’s supporters have sought to blame the central bank for the inflation crisis, and suggested that changes should be made to the bank’s mandate. The Bank of England was made independent from government ministers in 1997, a key reform introduced by the New Labour government which sought to distance monetary decisions from political pressures. However, Truss’s campaign has said she would be “more directive in setting its mandate” if she became prime minister.
Attorney General Suella Braverman, a Truss supporter, said that as prime minister she would “be looking into detail at exactly what the Bank of England does, and see whether it's fit for purpose in terms of its entire exclusionary independence over interest rates.” Truss herself has been vague on her intentions for the bank.
The debate over tax cuts, borrowing and monetary policy is likely to do little to relieve the anxieties of British bill payers, however, who are set to face the highest living costs in recent memory this winter. The power vacuum in government created by Boris Johnson's resignation means that it remains unclear exactly how much government support will be provided to consumers to reduce the coming financial pressures.
In the absence of a plan, civil society campaigners are becoming more vocal. A widespread strike is already being planned in the coming months, responding to cross-sectoral real wage reductions. And a new campaign urging consumers to refuse to pay their energy bills has been quickly gathering pace in recent days.
The Don’t Pay U.K. campaign group states that it is demanding “a reduction of energy bills to an affordable level.”
“Our leverage is that we will gather a million people to pledge not to pay if the government goes ahead with another massive hike on Oct. 1,” the group states. “Even if a fraction of those of us who are paying by direct debit stop our payments, it will be enough to put energy companies in serious trouble, and they know this. We want to bring them to the table and force them to end this crisis.”
In British minds the campaign will evoke memories of Margaret Thatcher's unpopular poll tax proposals, the widespread non-payment of which eventually brought down her government. Don’t Pay U.K. has claimed that 80,000 people have already pledged nonpayment, and that this figure is rising rapidly.
The government has dismissed the campaign as “highly irresponsible.” But it is a sign of the desperate financial situation that many British households will find themselves in as the economic crisis deepens, as well as an indication of the multiple and conflicting pressures that will face whichever candidate succeeds in their bid to become prime minister.
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