Fears that the British economy is headed for recession intensified after the Bank of England raised borrowing costs more than expected, with an increase to combat stubbornly high inflation that will cost borrowers, particularly home owners, who will have to refinance in the coming months. .
In a busy day for central bank action in Europe, the Bank of England said on Thursday that its nine-member monetary policy committee decided to raise its key interest rate by half a percentage point to a new 15-year high of 5 percent. All but two members of the panel supported a half-point increase.
The size of the bank’s 13th increase in a row was a surprise after most economists had forecast a smaller quarter-point increase. Some have even called it a panic move, given that as recently as last month there was hope that the bank would pause its rate-hiking cycle.
After Governor Andrew Bailey warned of further hikes if inflation fails to show clear signs of slowing, financial markets are pricing in a potential rate of 6 percent, which has not been hit since the early 2000s.
“We are committed to bringing inflation back to the 2 percent target and will take the necessary decisions to achieve it,” he said.
Apparently, the bank has been alarmed by the failure of inflation to decline as quickly as forecast from October’s peak of 11.1 percent. Wednesday’s figures showed UK inflation unexpectedly held steady at 8.7 percent.
Inflation in the UK has proved more stable than in other major economies and many have blamed the slowness of banks in raising lending rates and Britain’s exit from the European Union, which has raised import costs.
With wages rising rapidly, it is increasingly clear that high inflation is embedded in the economy.
“We know it’s difficult – many people with mortgages or debt will understandably be worried about what this means for them,” Bailey said. “But if we don’t raise rates now, it could be worse later.”
Across Europe, other central banks also decided to raise borrowing costs on Thursday, including the Swiss National Bank with a quarter-point increase and Norway with a half-point increase. Türkiye almost doubled its benchmark rate, signaling a shift from unconventional economic policies.
Banks around the world, from the U.S. Federal Reserve to the European Central Bank, have raised interest rates rapidly over the past few years to tame inflation spurred first by the pandemic and then by supply chain backups linked to Russia’s invasion of Ukraine. , leading to increased energy and food costs.
The Fed decided to keep rates unchanged last week but signaled the possibility of more hikes this year.
Pressure on borrowers
Higher interest rates help reduce inflation by making it more expensive for individuals and businesses to borrow money, which means they potentially spend less, reducing demand and putting pressure on prices.
The UK rate hike will put further pressure on borrowers, particularly the 1.4 million or so households who will need to refinance their mortgages over the rest of the year. Those on variable mortgages, which track the bank’s base rate, will face an imminent rise in repayments. Rents are also facing an increase.
“Raising interest rates to 5 percent would push millions of households to the brink of bankruptcy,” warned Max Mosley, an economist at the National Institute for Economic and Social Research.
Growth will clearly come at a cost, and there are concerns about the outlook for the British economy, which has avoided falling into recession even as Europe’s economy shrank slightly in the six months to March.
“It is increasingly difficult to see how the UK avoids a recession as part of the process of bringing down inflation,” said Luke Bartholomew, senior economist at asset management firm Abrdn. “And today’s large rate hike will likely be viewed in retrospect as an important milestone toward that recession.”
In a recession, unemployment will inevitably rise, and house repossessions will become more prevalent – hardly the backdrop the Conservative government wants ahead of a possible general election next year. It overtook the main opposition Labor Party in the polls.
Prime Minister Rishi Sunak, whose top priority is to halve inflation to around 5 percent this year, said he understood the “concern” people were feeling.
“I’m here to tell you that I’m totally, 100 percent over it, and it’s going to be OK, and we’re going to get through it,” he told workers at a warehouse in Dartford, east London.
Not everyone is convinced the bank is doing the right thing, arguing that previous interest rate hikes have yet to work their way through the economy. There is always a gap.
Paul Nowak, general secretary of the umbrella trades union Congress, said, “Pushing interest rates so high that they push the economy into recession will make the current crisis worse, putting people out of their jobs and their homes.”