The Bank of England has raised its key interest rate to 0.75 per cent from 0.5 per cent, amid mounting concerns that Russia’s war in Ukraine will drive up price growth.
The invasion has caused a “shock” to the UK, and follows “a succession of very large shocks”, the central bank said in a sober assessment of the domestic and global economic outlook.
Rate setters at the Bank of England expect inflation to reach around 8 per cent in April, when energy regulator Ofgem is due to raise its price cap by more than 50 per cent – about £700 for the average household’s bill.
The central bank now believes inflation will remain “close” to that level until at least June, signalling a long-term hit to households’ real incomes as they fail to keep pace with prices. These concerns drove policymakers to vote to return the key interest rate to a level last seen in March 2020, before the Covid pandemic took hold.
Still, price growth could gather pace in October, when another hike in the price cap is introduced. This increase in the price cap will have to factor in the impact of the war in Ukraine on energy markets, the Bank of England said.
Russia’s role as a commodities-exporting powerhouse has driven up the cost of oil and gas in recent weeks, as countries scramble to reduce their dependency on Vladimir Putin’s regime.
In a rare move, officials issued a strong condemnation of Russia’s “unprovoked” actions and the “suffering inflicted” on Ukraine, before warning of its likely impact on the British economy.
“The effects of Russia’s invasion of Ukraine would likely accentuate both the peak in inflation and the adverse impact on activity by intensifying the squeeze on household incomes,” rate setters at the Bank said.
The invasion is “likely to exacerbate global supply chain disruptions, and has increased the uncertainty around the economic outlook significantly”, according to a summary of the central bank’s deliberations.
For countries that are net importers of goods, such as the UK, that means there will be a negative knock-on effect on growth, as higher prices eat into household budgets.
Signs of households tightening their belts were gathered by the central bank’s regional agents, who gather data on the ground that reflect changes in the economy.
As concerns over the Omicron variant have eased, hospitality companies had reported a pick-up in demand, but lower-priced pubs and restaurants were outperforming their upmarket peers, the agents reported.
In a signal of further economic hurt to come, the central bank said that if prices for oil and natural gas remain at current highs, the increase in the price cap this October could be as high as an additional 35 per cent. Economists at investment bank Goldman Sachs have estimated that this lift on the cap could push inflation, as measured by the Consumer Price Index, to 9.5 per cent.
This comes as wages, after stripping out bonuses, are already failing to keep up with the rise in the cost of living, according to figures released by the Office for National Statistics earlier this week. A host of economists have warned that the UK faces its worst fall in living standards in nearly half a century this year.
The US central bank, the Federal Reserve, raised its key interest rates on Wednesday for the first time since 2018, while also raising its inflation outlook and cutting growth forecasts.
Raising domestic interest rates is a tool that has limited power to curb inflation generated overseas, but with unemployment falling to pre-pandemic levels in recent months, policymakers at the Bank were concerned about how this could lead to higher wages and thus feed inflationary pressures. A tighter labour market could risk a so-called wage-price spiral, concern over which last month led the Bank of England governor, Andrew Bailey, to warn workers against asking for big pay rises.
The “current tightness of the labour market”, along with fears that higher prices could prove persistent, ultimately pushed policymakers to raise the Bank’s key interest rate to 0.75 per cent.
However, one member of the central bank’s Monetary Policy Committee, deputy governor Sir Jon Cunliffe, did vote against the rate rise. Sir Jon feared that there could be a “very material negative” hit to the economy from higher oil and natural gas prices, exacerbated by Russia’s invasion of Ukraine. This could hurt business and consumer confidence, he warned.
But the balance on further increasing interest rates will be hard to strike, the Bank of England said. Higher interest rates might help curb inflation, but they can also slow down GDP growth.
