The Bank of England has said further interest rate hikes could be required to tame runaway inflation, as it implemented the biggest single increase since 1989. Gross domestic product (GDP) could shrink for every quarter for two years, with growth only coming back in the middle of 2024.
All but two members of the Monetary Policy Committee (MPC) voted to push up interest rates by 0.75 percentage points, from 2.25 per cent to 3 per cent, during a crunch meeting on Thursday. One member of the nine-person MPC voted for a 0.5 percentage point increase, while another wanted a much softer 0.25 percentage point rise.
The move will pile around £3,000 per year on to mortgage bills for those households that are set to renew their mortgages, the Bank said. But while further hikes could be necessary to pull inflation back to its 2 per cent target, the peak rate will be lower than what financial markets currently expect, the Bank said.
The pound fell after the Bank of England’s aggressive rate rise and warnings over a prolonged recession lasting two years. Sterling dropped 1.4 per cent to 1.123 against the US dollar and was 0.8 per cent lower at 1.15 euros.
The economy has faced similarly long recessions in the past, but then the quarterly drops have been broken up with an occasional positive quarter.
However the Bank cautioned that this forecast is based on interest rates reaching as high as 5.2 per cent, which the Bank said it does not necessarily expect to happen.
It could be a drawn-out recession, but will be less than half as severe as the 2008 financial crisis, the Bank said.
From its highest to lowest point, GDP is expected to drop 2.9 per cent, the Bank said, compared with 6.3 per cent during the financial crisis.
Meanwhile unemployment is expected to peak at around 6.5 per cent, from 3.5 per cent today, slightly lower than in 2008.
There was better news in the Bank’s inflation projection.
It had previously forecast inflation to peak at 13 per cent in the third quarter of this year, but with the Government’s support on household energy bills the forecast was slashed to 10.9 per cent.
Decision makers also said that more hikes were likely to come, however they do not expect rates to rise as high as the 5.2 per cent that the market has forecast for the final quarter of next year.
“The majority of the committee judges that, should the economy evolve broadly in line with the latest Monetary Policy Report projections, further increases in the Bank Rate may be required for a sustainable return of inflation to target, albeit to a peak lower than prices into financial markets,” the Bank said on Thursday.
It also warned there are uncertainties and said that if inflation looks to be more persistent than the current outlook it will “respond forcefully”.
Responding to the interest rate rise, Chancellor Jeremy Hunt said: “Inflation is the enemy and is weighing heavily on families, pensioners and businesses across the country.
“That is why this Government’s number one priority is to grip inflation, and today the Bank has taken action in line with their objective to return inflation to target.
“Interest rates are rising across the world as countries manage rising prices largely driven by the Covid-19 pandemic and Putin’s invasion of Ukraine.
“The most important thing the British government can do right now is to restore stability, sort out our public finances, and get debt falling so that interest rate rises are kept as low as possible.
“Sound money and a stable economy are the best ways to deliver lower mortgage rates, more jobs and long-term growth.
“However, there are no easy options and we will need to take difficult decisions on tax and spending to get there.”
Sir Keir Starmer said the single biggest increase of interest rates since 1989 will make people’s financial positions “much, much harder”.
The Labour leader told Times Radio: “It’s been hard enough already, this is going to make things much, much harder.”
He blamed 12 years of Conservative government for leaving the nation more exposed because of a lack of growth, saying mortgage-payers know they are paying a “Tory premium”.
Shadow chancellor Rachel Reeves told Rishi Sunak to “face up to his mistakes” that have led to the “vicious cycle of stagnation” after the Bank of England issued a stark inflation warning.
“Families now face higher mortgages and more anxiety after months of economic chaos,” the Labour MP said.
“Today’s recession warning lays bare how 12 years of Tory government has weakened the foundations of our economy, and left us exposed to shocks, lurching from crisis to crisis with falling living standards and low growth.
“As Chancellor and now Prime Minister, Sunak must face up to his mistakes that have led to the vicious cycle of stagnation this Tory government has trapped us in.
“Working people are paying the price for Tory failure. Britain deserves more than this.”
Liberal Democrat Treasury spokesperson Sarah Olney said Jeremy Hunt must set out a plan to “save homeowners” after the Bank of England increased its interest rate to 3%.
“The blame for today’s rate rise lies squarely with the Government,” she said.
The rise today comes following economic turmoil under Liz Truss's government – with more measures expected to be taken by RIshi Suank’s government.