The Bank of England has warned the economy will be on the brink of recession in an election year and signalled it intends to keep interest rates high for an extended period to tackle stubborn inflationary pressures.
After holding rates unchanged at 5.25% for a second consecutive time – the highest level since the 2008 financial crisis – Threadneedle Street said the risks from war in the Middle East and domestic inflationary pressures would force it to keep borrowing costs high despite a worsening outlook for growth.
“It’s much too early to be thinking about rate cuts,” said Andrew Bailey, the Bank’s governor.
“Higher interest rates are working and inflation is falling. But we need to see inflation continuing to fall all the way to our 2% target. We’ve held rates unchanged this month but we will be watching closely to see if further rate increases are needed.”
Issuing updated forecasts as Rishi Sunak’s government comes under growing pressure over his economic management in the run-up to an election expected next year, the central bank downgraded its forecast to say it anticipated flatlining growth throughout 2024.
Giving a 50-50 chance of a recession by the middle of next year – beginning around the time a spring election could be held – it forecast four consecutive quarters of zero growth in gross domestic product (GDP), should interest rates follow the path expected by financial markets.
The latest estimates raise the prospect of Sunak failing to meet one of the central targets of his premiership, to grow the economy.
Should rates be held at current levels for longer than markets anticipate, the Bank said Britain could crash into a recession by the summer. Economists regard two quarters of falling GDP as the technical definition of recession.
“At the start of the year, Rishi Sunak and Jeremy Hunt promised to get the economy growing. These figures show we are going in the wrong direction,” said Rachel Reeves, the shadow chancellor. “We are forecast to have gone from low growth to no growth, with working people paying the price.”
Financial markets rallied sharply after the Bank’s decision to hold interest rates – which was widely expected in the City – as investors bet the world’s leading central banks had reached the end of the most aggressive cycle of rate increases in decades. Similar decisions had been made by the US Federal Reserve and the European Central Bank.
The FTSE 100 closed up 1.4% at 7,446, as share prices rose across Europe and the yields on US and European government bonds – which move inversely to prices – fell back.
Bailey warned that rates may need to be increased further in the UK to ensure high inflation is squeezed out of the system.
“But we should not keep monetary policy restrictive for excessively long. We have to be mindful of the balance of risks between doing too little and doing too much,” he said.
The Bank estimates about half of the force of its previous increases has yet to be entirely felt in the economy, as millions of families brace for the end of cheaper fixed-term mortgage deals bought before it started raising borrowing costs from a record low of 0.1% in December 2021.
Exposing divisions over the risk of persistent inflationary pressures, the Bank’s monetary policy committee voted by a majority of six to three to keep rates on hold. A minority – the external members Catherine Mann, Megan Greene and Jonathan Haskel – pushed to restart the cycle of rate increases by calling for a quarter-point rise.
Inflation in the UK remained at 6.7% in September after a sharp rise in fuel costs for motorists in recent months offset weaker growth in the cost of a weekly food shop. Britain has the highest inflation rate among the G7 group of advanced economies.
Threadneedle Street said it expected previous rate increases would help to bring inflation down to about 4.75% by the fourth quarter of 2023 – meaning Sunak would narrowly meet his pledge to halve the inflation rate this year from 10.7% at the end of last year.
The chancellor, Jeremy Hunt, said: “The UK has been far more resilient than many expected, but the best way to deliver prosperity is through sustainable growth.”
The Bank still expects to reach its 2% target on inflation by the end of 2025, but Bailey warned further action could be needed. “The risks to inflation remain on the upside. So in a sense that conditions our view for the path for rates,” he said.
Financial markets anticipate a cut in rates could come before autumn next year.
Modupe Adegbembo, a G7 economist at Axa Investment Managers, said: “We cannot discount the risk that inflation remains more persistent than we are anticipating and the Bank is forced to keep rates on hold for longer.
“On the other hand, there is a risk that the Bank could be forced to unwind rates earlier and faster if the growth outlook deteriorates faster than we are currently anticipating.”
