By October, inflation will rise to over 10% - the highest level in 40 years as Britain risks a recession as millions will have higher bills to pay.
The Bank of England raised interest rates by 0.25% to 1% in a bid to curb the runaway cost of living and warned the economy is likely to contract in the final quarter of the year.
In comments urging Chancellor Rishi Sunak to provide greater support to families in need, the Bank said little could be done to help with an unprecedented rise in electricity bills and the second-largest drop in living standards since the registration started. Labour accused ministers of "shaking" the crisis, while economists urged Sunak to offer more bailouts to avert a recession in the UK.
Households are expected to face a devastating 40% rise in electricity bills this winter, pushing inflation to 10.25%, a level not seen since 1982. The average gas and electricity bill is expected to hit £2,800 when Ofgem raises its price cap to reflect the surge in wholesale energy prices exacerbated by the war in Ukraine. Prices for food and other basic necessities are also expected to continue to rise, the Bank's Monetary Policy Committee (MPC) said Thursday.
The MPC warned that while wage growth will be higher than previously forecast, household disposable income will continue to fall sharply. As consumers cut spending, the economy is expected to contract in the final quarter of 2022.
The sales decline is expected to peak at the end of this year and then ease in 2023, but spending will be limited by continued high energy prices. While the UK will technically avoid a recession, defined as two consecutive quarters of negative growth, it won't be reassuring as households face an average income cut of £1,200.
“These poor prospects for living standards can make monetary policy decisions difficult, but they make fiscal policy decisions much easier,” said James Smith, deputy director of the Resolution Foundation think tank.
“Governments cannot protect all of us from the pain of rising energy prices, but they can and should provide more targeted support to the low- and middle-income households most affected by this cost of living crisis.”
The Bank currently forecasts zero growth in 2023, then 0.2% in 2024 and 0.7% in 2025. These figures will increase pressure on Rishi Sunak to do more to help households struggling with rising bills. Some cabinet colleagues have urged the Chancellor to cut taxes to limit the contraction of the UK economy. A minister urged Mr Sunak to cut VAT, telling The Times: “A recession seems inevitable, maybe we're already in it. What we are hearing from retailers is appalling, prices are skyrocketing."
Despite what it called a "material deterioration in the outlook" for the UK and the global economy, the MPC voted for a fourth consecutive 0.25 percentage point rate hike in a bid to tame inflation. Inflation, measured by the consumer price index, is already at 9.1% in the second quarter of this year, the highest level in four decades.
The MPC acknowledged that there is little monetary policy can do to offset the second largest drop in disposable income since registration began. Inflation is expected to fall sharply in 2023, before falling below the Bank's target of 2 per cent in 2024 and 1.3 per cent in 2025. The bank said it had made the decision to raise rates because of "the tight labour market, continued signs of strong pressure on domestic costs and prices, and the risk of continued pressures." He also warned of the risk that energy prices could rise more than expected this winter, especially if Russian gas flows to Europe are significantly reduced.
"In such a scenario, European gas prices are likely to rise sharply and the amount of gas could be rationed next winter as gas supplies in the EU could dry up," the bank said in a statement. He warned that Russia's war in Ukraine, coupled with potentially serious Covid outbreaks in China, could further disrupt supply chains, further fueling inflation.
Thursday's 0.25% hike pushes the base rate to its highest level in 13 years, boosting monthly mortgage payments for borrowers on variable and tracked deals. Three members of the nine-member committee argued for tougher measures against inflation and called for an interest rate hike of 0.5%.
Markets are pricing in a series of further hikes in the coming months that could push key interest rates up to 2.5%. The MPC confirmed on Thursday that it believes "some degree of further monetary tightening in the coming months may still be appropriate". Labor Shadow Chancellor Rachel Reeves said rising interest rates and bleak economic forecasts would "concern families across the country, already coping with rising prices and bills."
“Ministers are not only shrugging off the growing cost of living crisis, they have exacerbated it by hitting workers and businesses with 15x conservative tax hikes, further stifling our economic growth,” she said.
The bank has also indicated that it will soon be able to sell £875 billion in government bonds it has bought under its quantitative easing programme. The staff has embarked on a sales strategy, but the decision of whether or not to proceed has been postponed to future MPC meetings and remains subject to economic conditions.
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