ALEX BRUMMER: Bank of England hits the alarm button as it finally faces up to the threat of inflation and surging energy prices
After a lengthy period of complacency, the Bank of England has finally woken up to the extreme threat that surging energy prices and inflation pose – not just to the prosperity of Britain, but to the whole world.
The prospect of recession – though not as deep as the one that followed the great financial crisis of 2007-08 – looms into clear view.
The UK, as one of the most open economies on the planet, is particularly vulnerable to crises that are driven by geopolitical upheaval.
Rate rise: Bank of England economists have warned that UK inflation will hit a peak of 10% later this year before it subsides
Bank of England governor Andrew Bailey is now showing a grim determination to crush runaway prices.
For the fourth successive time, the Bank has chosen to raise interest rates by a quarter of a percentage point. The key bank rate now stands at 1 per cent.
The action follows hard on the heels of similar steps by the American central bank, the Federal Reserve – which hiked interest rates by half a percentage point on Wednesday – and other rate setters around the world, from Australia to Sweden.
An era of low borrowing costs and some of the cheapest home loans in the UK’s history is coming to an abrupt end. Some consumers will be protected for a time by fixed-rate deals.
The ‘crisis upon crisis’ of the pandemic, followed so swiftly by the barbaric Russian war on Ukraine, has exacerbated a surge in the cost of living already happening as a result of kinks in business supply chains and surging freight prices.
It is now conceded at the Bank that UK inflation will hit a peak of 10 per cent later this year before it subsides.
The Bank cautions ‘we may need to increase interest rates further in the coming months’.
The pain is going to get much worse for householders with Bank economists projecting that the bank rate will rocket to 2.5 per cent by this time in 2022.
Indeed, three members of the interest-rate setting Monetary Policy Committee were so concerned about the inflation bogey that they wanted a full half percentage point rise at this week’s May session.
Britain finds itself in a particularly bad place. The cost of living crisis, fuelled by an escalation in oil, gas and grain prices, coincides with an ill-timed drive by the Chancellor Rishi Sunak to restore some sanity to the public finances after spending an estimated £311billion on Covid-19 measures.
The UK is the only rich economy to be facing the double hazard of higher taxation, a tightening of fiscal policy and a harder monetary regime, at one and the same time.
This is a catastrophic combination, resulting in an enormous squeeze on the real (inflation-adjusted) incomes of every person in the land.
Using unusually fierce language, the Bank of England projects that the amount of income that households have to spend will drop this year by the largest amount since records began in 1964, when the Labour government of Harold Wilson occupied Downing Street.
The consequence of all this is that instead of 2022 being a bumper recovery period for the British economy, it will hit the buffers as the year progresses and the country faces recession in 2023 instead of previously forecast anaemic growth of 1.2 per cent. It will barely grow in 2024.
The only saving grace is that because the UK starts out with strong employment, the long dole queues of the past should be avoided. The jobless rate is expected to creep up over the next three years, peaking at 5.5 per cent of the workforce by 2025.
Boris Johnson and the Chancellor face some tricky decisions.
In times of slump, a welfare net of unemployment benefits and social security helps to ease the pain.
But they may need to do more. Rescinding the 1.25 percentage point rise in national insurance on employees and employers would be an enormous help.
But as a core Tory policy for resolving problems of the NHS and social care, it would be politically humiliating.
Hardship could be mitigated by a ‘wartime’ increase in universal credit, dropping the freeze on inflation adjustment to tax allowances and reversing next year’s increase in company taxes.
All of these measures would be resisted by the Treasury.
But economic emergencies call for drastic solutions.