The economic picture painted by the Bank of England of the years ahead was unremittingly grim: a long recession, high inflation, falling living standards. It would be hard to find a worse set of conditions for a government before a general election.
Threadneedle Street was taking plenty of flak even before it announced its latest gruesome forecasts. It can expect no letup now, because the government will need to find a scapegoat for the misery to come.
And there could be plenty of that. The fact that the Bank’s monetary policy committee raised interest rates for a sixth meeting in a row came as no shock. More surprising was the downbeat nature of the predictions that accompanied the MPC’s decision.
Inflation is now expected to peak at 13.3% in October – its highest since September 1980 – and will still be close to 10% in a year’s time. The economy will begin to contract in the final three months of this year and not start to grow again until early 2024. Living standards will fall by 5% over the next two years – a drop unmatched since modern records began in the early 1960s.
Against this backdrop, the MPC pushed up interest rates by 0.5 percentage points to 1.75%. Not only was it the biggest increase in the official cost of borrowing since 1995, it was also the first time the committee has raised rates while forecasting a recession.
Eight of its nine members voted for a 0.5-point increase, on the grounds that the labour market remained tight and there was a risk of inflation becoming embedded. But the labour market is not expected to stay strong for long – the Bank thinks a recession, projected to last as long as those of the early 1980s and the late 2000s, will push unemployment from under 4% to well over 6% by 2025. Longer dole queues and higher interest rates will lead to a marked cooling in the housing market.
The forecasts are based on two assumptions: that the financial markets are correct to think interest rates will peak at 3% and that there will be no further government support for struggling households. Both are questionable. Some analysts think the economy is so weak the Bank will stop tightening after one or two more rate rises. There will certainly be more help with energy bills this autumn, whoever is prime minister.
Politically, the Bank has rarely been in a tighter spot. A year ago it thought inflation would peak at 4% but it has raised its forecast steadily ever since. Andrew Bailey, the Bank’s governor, rejected criticism that the MPC had been asleep at the wheel and was now slamming on the brakes at exactly the wrong time. The Bank says higher energy prices, which alone account for half the 13% annual inflation rate, and global supply chain bottlenecks are responsible for most of the increase.
Bailey said pain was inevitable but it would be even worse if the Bank allowed inflation to take root. The MPC’s warning that it will be “particularly alert to indications of more persistent inflationary pressures” means another half-point increase is possible next month.
Both Conservative leadership contenders said the Bank’s forecasts supported their economic plans: in Rishi Sunak’s case, that bringing down inflation was the number one priority; in the case of Liz Truss, that tax cuts were needed to fend off recession.
Truss, the frontrunner to replace Boris Johnson as prime minister, has been openly critical of Threadneedle Street. At the very least, she would order a review of the Bank’s mandate – the legal obligation to hit the government’s 2% inflation target – but she has been hinting at going further. For the first time since it was granted the freedom to set interest rates by Gordon Brown in 1997, the Bank’s independence looks to be under threat.
