The Bank of England (BOE) has raised its benchmark interest rate by 0.5 percentage points to 1.75 per cent.
The BOE Monetary Policy Committee (MPC) made the decision to hike its policy rates at its meeting yesterday as a result of inflationary pressures in the United Kingdom (UK) and the rest of Europe, which have increased dramatically. Due to Russia’s restriction of gas supply to Europe and the possibility of more restrictions, wholesale gas prices have nearly doubled since May.
In the short run, this will worsen the decline in real family incomes in the UK and raise UK consumer price index (CPI) inflation, as it cascades through to retail energy costs. From 9.4 per cent in June to just over 13% in 2022, CPI inflation is anticipated to increase more than expected in the May report.
It is also anticipated to be quite high for a significant portion of 2023 before declining to the two per cent target two years from now. The forecast for activity in the UK and the rest of Europe has significantly worsened, as a result of the most recent increase in gas prices.
UK projected to see recession starting Q4 of 2022
According to current projections, the UK will experience a recession starting in the fourth quarter of this year. In 2022 and 2023, it is anticipated that real household post-tax income would drop precipitously as consumption growth turns negative.
Domestic inflation pressures are expected to remain strong over the first half of the forecast period. The labour market remains tight, with vacancies at an all-time high and the unemployment rate at a record low.
The MPC reports that, “nevertheless, inflationary pressures are projected to dissipate, with tradable goods price inflation slowing. The labour market may only gradually relax in reaction to a decline in demand, but starting in 2023, unemployment is expected to increase. The pressure on wage growth is lessened by the rising level of economic slack and the decline in headline inflation.”
Additionally, monetary policy works to maintain longer-term inflation expectations at the two per cent target. At this time, both domestic and foreign factors pose very high risks to the MPC’s predictions.
The CPI inflation and medium-term activity might be much higher or lower than in the initial predictions in the August Monetary Policy Report under a variety of conceivable scenarios for the economy. The MPC is presently giving less weight to the effects of any particular set of conditioning assumptions and forecasts when making its assessment of the future and its implications for monetary policy as a result.
MPC’s mandate is clear
Given the importance of price stability in the UK’s monetary policy framework, the MPC’s mandate is very clear in that the inflation target is applicable at all times. The economy has continued to experience a string of extremely significant shocks, which unavoidably causes output to fluctuate. As these shocks are adjusted for, monetary policy will ensure that CPI inflation returns to the two per cent target sustainably in the medium term.
The labour market remains tight, and there are significant domestic cost and pricing pressures. A longer period of internationally driven price inflation may result in more persistent domestic price and wage pressures.