The Bank of England has warned that the British will face two years of falling household incomes with inflation set to soar to more than 13% and the economy to plunge into the longest recession since the financial crisis.
The bank made a grim outlook, raising interest rates from 1.25% to 1.75%, the biggest increase in 27 years. This move, aimed at curbing runaway inflation, puts additional pressure on mortgage holders.
Given the gloomy outlook for the UK economy, the Bank’s Monetary Policy Committee (MPC) forecasts inflation peaking in October at 13.3%, the highest in more than 42 years.
The runaway spending has a lot to do with soaring energy prices as the aftermath of Russian President Vladimir Putin’s war against Ukraine sent gas prices skyrocketing.
Regulator Ofgem is expected to raise the electricity bill limit for households to around £3,450 in October, the bank said.
Energy prices will help kick off a five-quarter recession as the Bank projects a contraction in gross domestic product (GDP) every three months from October to early 2024. GDP will decline by as much as 2.1%, the Bank said.
The report paints a harsh picture for households. In real terms, their after-tax income should fall by 1.5% this year and 2.25% next, despite ongoing government support.
This will be the first time since records began in the 1960s that household incomes have fallen for two consecutive years.
Joseph Rowntree Foundation Chief Economist Rebecca McDonald said: “We already know that this year seven million low-income families had to sacrifice food, heating and even showers because they couldn’t afford it.
“While the government may have taken a break from action due to the extraordinary cost of living, these families cannot take a vacation after a year of financial fear.
“They will be wondering why the further urgent decisions needed to bolster family finances ahead of winter have not yet been made.”
She added that higher interest rates would also put pressure on homeowners.
Bank Governor Andrew Bailey insisted that a rate hike from 1.25% to 1.75% – bringing rates to their highest level since January 2009 – was necessary to control inflation.
“Inflation hits the poorest hardest. But if we do not act now to prevent inflation from becoming sustainable, the consequences will be even worse later and require larger interest rate hikes,” he said.
The bank said the economy would at least avoid the effects of the 2008 or Covid-19 crash, which dealt a much larger blow to GDP.
The fall will be more comparable to the recession of the early 1990s.
Mr Bailey said the war in Ukraine has “economic costs”.
“But I must be clear, this will not distract us from setting monetary policy to bring inflation back to the 2% target,” he said.
The Bank’s latest forecast is that inflation will be back under control in 2023, falling below 2% by the end of the year.
He also predicts that unemployment will start rising again next year.
GDP is expected to grow by 3.5% this year, the Bank said, revising its previous forecast by 3.75% downward. Then next year it will decrease by 1.5%, and in 2024 by another 0.25%.
The decision to set the interest rate at 1.75% was made almost unanimously. Only one member of the MPC, which sets the rates, voted for a smaller increase in the base rate.
Predictions are likely to be featured in the ongoing competition for the leadership of the Conservative Party.
Favorite Liz Trouss said she plans to review the Bank’s independent mandate to make sure it is “hard enough focused on the money supply and inflation.”