Bank of England warns of longest recession in 100 years as it raises interest rates to 3%

The Bank of England has warned that Britain is at risk of falling into its longest recession in 100 years after it pushed the cost of borrowing up to 3% in the biggest single rate hike since 1989.

A 0.75% increase, the latest in a series of eight rate hikes since last year, would not be enough to guarantee victory in the war against double-digit inflation, the bank said, as it warned that further action would be needed.

The UK economy faces a “very challenging outlook”, with a recession that started this summer now expected to last until mid-2024.

With the possibility of a general election in 2024, the Conservatives face a campaign to stay in government at the end of a prolonged recession, during which the Bank said it expected unemployment to rise from 3.5% to 6.5% .

However, there was some relief for mortgage holders as the central bank downplayed the City’s expectations of a sharp rise in the cost of borrowing to above 5%, arguing that the prospect of a two-year recession meant it was likely to take a much less aggressive stance.

Andrew Bailey, the bank’s governor, said: “We can’t make promises about future rates, but based on where we stand today, we think Bank Rate will need to go up by less than what is currently priced in the financial markets.”

Bank of England interest rate rises

Bailey and his officials expect inflation to fall to zero by 2025, and analysts at Berenberg Bank predict just one more rate hike, to 3.5%.

Bailey said higher borrowing costs are already affecting households.

“These are big changes and have a real impact on people’s lives,” he told a news conference after the publication of the bank’s quarterly monetary policy report.

Homebuyers with tracker or variable rate mortgages will feel the pain of the rate hike immediately, while the estimated 300,000 people who will have to remortgage this month will find that two-year and five-year fixed rates remain at levels not seen since the 2008 financial crisis.

The bank said the cost of fixed-rate mortgages had already fallen from levels seen at the height of the panic in the wake of Kwasi Kwarteng’s ill-received mini-budget, which saw them soar above 6%.

Bank of England raises interest rates to 3% in biggest single step in 30 years – video

Mr Bailey hinted at the bank’s concern about the fragility of the housing market and said he hoped mortgage lenders would respond by continuing to cut the cost of their products for home buyers.

Bailey said he recognized the pain caused by tighter interest rate policy, but added: “If we don’t act forcefully now, it will be worse later.”

The bank now expects inflation, which reached 10.1% in September, to peak at 11% in late 2022, before falling “probably quite sharply” from mid-2023.

It blamed higher energy prices and a tight labor market for the big increase, which matched aggressive gains in the past week by the U.S. Federal Reserve and the European Central Bank.

The last time UK rates rose by more than 0.5% was in 1989. John Major’s government was forced into a 2% rise during the Exchange Rate Mechanism crisis in 1992, but for less than 24 hours before it was scrapped.

The vote to raise rates was split 7-2 among the nine-member Monetary Policy Committee (MPC) after Silvana Tenreyro voted for a 0.25% hike and Swati Dhingra voted for a 0.5% jump. Both are professors at the London School of Economics. They argued that the full effects of eight consecutive upswings should be allowed to permeate the wider economy before more serious action was taken.

Chancellor Jeremy Hunt said: “Inflation is the enemy and weighs heavily on families, pensioners and businesses across the country. That’s why this Government’s first priority is to tackle inflation, and today the Bank has taken action in line with their aim to return inflation to the goal.”

Rachel Reeves, the shadow chancellor, said: “Families now face higher mortgages and more worry after months of financial chaos.

“Working people are paying the price for Tory failure. Britain deserves more than this.”

On alternative assumptions that interest rates remained unchanged at 3%, the economy would still continue to shrink until the end of 2023, but the cumulative fall in output would be 1.7% rather than 2.9%, and unemployment would peak at just over 5 %.

The bank said it had not considered any action from Hunt in his autumn statement on November 17, although the chancellor is expected to announce a package of tax rises and spending cuts worth up to £50bn.

Kallum Pickering, a UK analyst at Berenberg, said: “Although a lot will depend on the coming [budget] announcement, today’s policy decisions and guidance support our call that the Bank will raise Bank Rate just one more time by 0.5 basis points in December to a peak of 3.5%.

“After that, we expect the Bank to remain on hold for the first half of 2023 before cutting the Bank Rate modestly, by around 0.5 basis points, in the second half of 2023.”

The risks on this call lean slightly towards another 0.25 point increase in February.”

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