The Bank of England unveiled a dismal vision for the British economy Thursday, predicting a long recession starting later this year as the impact of high inflation bites. But the central bank strengthened its effort to tackle soaring prices as it raised interest rates by half a percentage point, the largest jump since 1995.
The bank increased its benchmark rate to 1.75 percent, the highest since 2008, as it forecast the annual rate of inflation would climb above 13 percent when household energy bills jump higher in October. That would be the highest level of inflation in 42 years, and six times higher than the bank’s 2 percent target.
Much of the surge in prices is still coming from the global energy market, the bank said. In the past three months, wholesale natural gas prices for this winter have nearly doubled, which is expected to push the cap on household energy bills up to 3,500 pounds (about $4,245) in the fall, three times higher than bills were a year ago, the bank predicted.
The outlook for millions of British households is grim. Incomes, adjusted for inflation and taxes, are predicted to fall sharply this year and next, in the worst decline in records dating to the 1960s.
Britain, the world’s fifth-largest economy, will enter a recession in the last quarter of this year that will last through to the end of 2023, the bank forecast, the same length of time as the recession after the financial crisis in 2008.
“The latest rise in gas prices has led to another significant deterioration in the outlook for activity” in Britain and the rest of Europe, policymakers said, according to minutes of this week’s meeting. Britain “is now projected to enter recession.”
The rate change announced Thursday was the sixth increase since December as the bank tries to tackle inflation, which is running at its fastest pace in four decades. It has been under some pressure to increase rates by more than its usual quarter-point move as inflationary pressures persist and other major central banks also take more aggressive action to halt price increases.
The Bank of England was the first major central bank to start raising rates in response to the global inflation fight as it reined in monetary policies that supported economies during the pandemic. The European Central Bank last month raised interest rates for the first time in more than a decade. And in the United States, the Federal Reserve last week raised rates by three-quarters of a percentage point for the second straight month.
There is little the banks can do to slow energy prices or ease supply chain disruptions, but their goal is to make sure rapid price rises do not last too long by making it more expensive for consumers and businesses to borrow money. So far, unemployment has remained generally low in the United States, the European Union, and Britain, but the risk is that in trying to bring down inflation, policymakers will cause deep downturns and layoffs. The International Monetary Fund warned last month that a global recession could be at hand.
Global inflation has been exacerbated by the war in Ukraine, and the Western sanctions imposed on Russia that have further interrupted supply chains and driven up the cost of energy.
“There is an economic cost to the war,” Andrew Bailey, the governor of the bank, said Thursday. “But it will not deflect us from setting monetary policy to bring inflation back to the 2% target.”
In Britain, consumer prices rose 9.4 percent in June compared with a year earlier, faster than inflation in the United States and the eurozone.
The National Institute of Economic and Social Research, a London-based think tank, said Wednesday that the economy was entering a recession in this quarter and would lose 1 percent of gross domestic product over three quarters.
“We’re really in stagflation here,” Stephen Millard, deputy director of the research institute, said before the bank’s decision.
As high inflation meets a recession, household incomes are being squeezed because pay growth is not keeping up with rising prices. The research institute has called for more government support to low-income households as food prices continue to rise and household energy bills jump, perhaps by as much as 75 percent in the fall.
The Bank of England’s own forecasts are even gloomier. Next year, the economy will contract 1.5 percent, it predicted, assuming no change in fiscal policy. It shows the scale of the economic challenge facing the two Conservative lawmakers battling for the party leadership and role of prime minister. Much of the debate so far has centered on taxes, with Liz Truss, the front-runner, vowing to quickly cut them for workers and businesses amid a cost of living crisis.
Truss has also said she would reevaluate the bank’s mandate from the government to ensure price stability, to make sure “it matches some of the most effective central banks in the world at controlling inflation.” The central bank has been independent of the Treasury since 1997, but the government still sets the inflation target. Truss added that it had been a long time since the mandate was scrutinized.