When Bank of England officials meet this week to consider how much to raise the central bank’s base rate by, they could be forgiven for having spent the previous day scratching their heads.
There are figures that show the UK economy is – like an 18th-century depiction of John Bull after a feast of pies – straining at full capacity. In normal times, low unemployment and a record number of vacancies would indicate a boom in full swing.
These, however, are not normal times. A majority of businesses report slowing consumer demand as wages fail to keep pace with soaring inflation. Rather than a vision of plenty, the latest surveys depict a slowing economy heading for recession.
Governor Andrew Bailey and his eight colleagues on the monetary policy committee (MPC) are expected to increase the base rate from 1.25% to 1.5%, pushing the average mortgage borrowing APR to 3.5% or more. But such is the confusion about how to deal with an inflationary spiral that has taken annual price rises to 9.4% that the vote is expected to be split.
Samuel Tombs, chief UK economist at Pantheon Macroeconomics, says most MPC members will be reluctant to impose a big rate rise: “It’s a close call, but on balance we think the committee will stick to its slow-and-steady approach.”
Luke Bartholomew of fund manager Abrdn is betting on a more aggressive stance, however. He says increased government spending and rising gas bills will force the Bank to raise rates by 0.5 points.
Some committee members voted for a half-point increase at the last meeting in June, arguing that a short, sharp shock was needed to calm consumer spending.
Catherine Mann, the MPC member and former investment bank economist, added an extra twist in her most recent speech, saying that the UK needed much higher interest rates to protect the pound, which had fallen against the dollar by more than 10% since the beginning of the year. A lower pound pushes up the cost of imports and the rate of inflation.
Her argument is likely to be made again at this week’s meeting after the US Federal Reserve signalled that a 0.75-point increase in the base rate last week to 2.5% is likely to be followed by another 0.75-point rise in the autumn.
Higher interest rates act as a magnet for global savings, increasing the demand for the currency. If UK interest rates lag behind those in the US, sterling is at a distinct disadvantage.
Fed officials’ threats of ever-higher interest rates may never come to pass. US GDP figures last week showed the economy shrinking in the second quarter by 0.9% after a 1.6% contraction in the first quarter, pushing the US into recession.
Plenty of economists believe the UK is heading in the same direction. They say unemployment in the UK is low because there was an exodus of workers in the wake of the Brexit vote, and because long Covid is still affecting about 500,000 workers.
Chris Williamson, chief business economist at S&P Global Market Intelligence, compiles one of the most keenly watched monthly business surveys. He says the economy doesn’t need an extra push into recession from the Bank. All the indicators he sees show it is heading in that direction anyway.
“If the central bank raises rates, it is going to have a recession, and quite a deep one,” he says. “Maybe a deep recession is what the Bank wants. I just think it shouldn’t be surprised if that happens.”
John Bull was depicted two and a half centuries ago as a wealthy farmer, and there are plenty who have made money from high wheat prices over the past two years. But recessions can send commodity prices plummeting. Wheat prices are already down a quarter from their peak in May, in response to recession concerns.
A recession across the developed world will see them fall further, bringing down inflation and ending any further need for interest rate rises.
