The Bank of England raised interest rates for a tenth consecutive time on Thursday from 3.5% to 4%, but said inflation may have peaked and a recession in the UK would be shorter and shallower than previously feared.
Piling more pressure on mortgage payers and businesses struggling to pay off their loans, the Bank’s monetary policy committee (MPC) said the 0.5-percentage point rise was needed after private sector wages had risen more than the central bank’s previous forecasts.
Publishing an updated outlook for the economy alongside the rate decision, the Bank said that inflation “is likely to have peaked” and a recession would be less severe than previously predicted, but said Brexit was damaging the economy more quickly than it had anticipated.
“Brexit … has been something that has pulled on our potential output in our country and that’s been our assessment for many years,” said Ben Broadbent, a deputy governor of the Bank.
“We’ve not changed our estimate of the long-running effects, but we’ve brought some of them forward and we think they’re probably coming in faster than we first expected. Based on the numbers for trade and some degree for the numbers on investment, we think these effects are coming through faster than initially envisaged.”
Predicting a shallower recession, the Bank said economic output would fall by 1% from peak to trough, compared with the 3% drop it was expecting at the time of its November outlook.
Bank staff raised their forecast for the UK’s GDP growth rate in the final quarter of 2022 GDP to 0.1%, which would mean the UK narrowly avoided entering a technical recession at the end of last year after the economy shrank in the third quarter. Official figures for fourth-quarter growth will be published next week.
However, the economy is forecast to contract in each quarter of 2023 and the first quarter of 2024 before staging a modest recovery.
The governor, Andrew Bailey, said inflation had turned a corner after a dramatic fall in gas prices on international markets, but there was a strong risk that rising wages and a possible return of soaring gas costs later in the year would push inflation higher again.
Adding that the risk of a rebound in inflation was at the highest level in the MPC’s 25-year history, he said: “We need to be absolutely sure that we really are turning the corner on inflation.”
The Bank expects the headline rate of inflation to fall rapidly this year from December’s 10.5% to 3.5% by the end of the year, and then 1% in 2024. The Bank has an inflation target of 2%.
The shadow chancellor, Rachel Reeves accused ministers of sitting on their hands while families suffered higher inflation and higher interest rates. “Families across the country will be worried about what rising interest rates today mean for them,” she said.
The Resolution Foundation thinktank said the bank’s analysis showed that the UK is in the midst of the weakest 20-year period of growth since before the second world war. “The UK is currently in the midst of a 20-year period in which annual growth averages just 1% between 2006 and 2025 – the weakest 20-year period of growth since 1919-1938,” it said.
Jeremy Hunt’s tax rises, which are due to begin hitting household incomes from April, will cut GDP growth by 0.4% next year, the Bank has calculated.
Responding to the Bank’s latest rate rise, Hunt said lowering inflation was his top priority because it was “the biggest threat to living standards in a generation, so we support the Bank’s action today so we succeed in halving inflation this year”.
He said the government’s tax policies were in “in lockstep with the Bank’s approach, including by resisting the urge right now to fund additional spending or tax cuts through borrowing, which will only add fuel to the inflation fire and prolong the pain for everyone.”
The 0.5-point increase was forecast by City analysts, who expect the Bank to raise interest rates again to 4.5% in the spring before a series of cuts next year brings the Bank rate back to 3.5%.
More than 1.5 million mortgage payers are expected to suffer an average £3,000-a-year increase in interest payments when they refinance their loans this year, as well as the hundreds of thousands of households that refinanced at higher rates in 2022.
Monthly bills for households in the rental sector have rocketed, a rise that landlords are blaming on higher borrowing costs.
Two members of the nine-member MPC voted to keep rates at 3.5%, arguing that the effects of previous rates rises had yet to feed through into the wider economy.
Silvana Tenreyro and Swati Dhingra, both seconded from the London School of Economics to the MPC, have repeatedly warned that the central bank underestimates the impact of previous interest rate rises and should pause to judge the effects on mortgage holders, renters and small businesses before taking further action.
The MPC’s majority view was that it would “continue to monitor closely indications of persistent inflationary pressures, including the tightness of labour market conditions and the behaviour of wage growth and services inflation”. In a warning to workers, it said if there was evidence of “more persistent pressures, then further tightening in monetary policy would be required”.
The MPC said GDP would only reach its previous 2019 peak in 2026, indicating that a combination of staff shortages fuelled by the Covid-19 pandemic and Brexit combined with high energy prices had reduced the economy’s capacity to grow.
After the turmoil in financial markets that followed Liz Truss’s mini-budget, investors forecast interest rates peaking at 5.25%, but the highest they expected before today’s meeting was 4.5%.
Private sector wages increased by 7.2% in the three months to November, according to official figures that showed the highest rises going to workers in the financial services sector and business services, such as accountancy and the legal industry. Most negotiated wage rises are about 4%, according to industry surveys.
