The Bank of England is setting the biggest interest rate hike in 33 years and warning of a long recession
The Bank of England raised interest rates by three-quarters of a percentage point on Thursday, the biggest increase in 33 years, as it tries to rein in rising inflation even as the UK economy is sliding into recession it could take two years.
The central bank made its eighth interest rate hike in less than a year, raising the benchmark rate to 3%, the highest since November 2008.
“Inflation is too high, and it’s the bank’s job to bring it down,” Governor Andrew Bailey said at a news conference after the announcement. “If we don’t act strongly now, it will be worse later.”
As the Bank of England raises borrowing costs to curb rising prices, the UK economy is expected to suffer.
The central bank believes that economic output is already shrinking, and its latest projection is that the recession will continue into the first half of 2024 “as high energy prices and materially tighter financial conditions weigh on consumption.”
Compared to past UK recessions, gross domestic product is forecast to remain weak from pre-recession levels for an “extended” period, Bailey said.
The two-year recession would be longer than the one that followed the 2008 global financial crisis, although the Bank of England said any drop in GDP heading into 2024 was likely to be relatively small.
The British pound fell sharply after the announcement, falling 2% against the US dollar to $1.117. It also fell by 1.2% against the euro.
Since the Bank of England’s last meeting, UK financial markets have gone through a period of unprecedented turbulence and the outlook for the economy worsened.
Former prime minister Liz Truss’ “mini” budget at the end of September — with a promise of £45 billion ($51.6 billion) in unfunded tax cuts — crashed the poundcollapsed bond prices, spark chaos in the mortgage markets and encouraged an emergency intervention by the Bank of England to bail out strained pension funds.
While Truss’ plans to cut taxes since then have largely been ditched, restoring market calm and softening inflation expectations in the medium term, rising food and energy costs are keeping prices high. The annual inflation rate rose to 10.1% in September, from 9.9% in August, returning to a 40-year high reached in July.
Bailey admitted there was a “difficult road ahead”.
The central bank does not think inflation will start to fall until next year. That will require more interest rate hikes in the coming months, although Bailey said market expectations looked too aggressive.
Those remarks contrasted with those made Wednesday by Fed Chairman Jerome Powell, who said rates may have to rise more than previously expected.
Central bank policy makers they now await the government’s budget announcement on November 17 for more details on spending plans and tax policy, which could affect what happens to inflation next year.
Despite the recent turmoil in the bond market, the Bank of England pressed ahead with plans to reduce its balance sheet this week, selling 750 million pounds ($859 million) of short-term government debt on Tuesday. In a sign of renewed confidence in the United Kingdom, investors bid about 2.45 billion pounds ($2.8 billion) for the bonds, Reuters reported.
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