'Time to batten down the hatches' warning from Bank of England as recession looms

Cost of living: Why Bank of England has increased interest rates

The big squeeze got even worse after Bank Governor Andrew Bailey, pictured, raised interest rates to 1.75 per cent – and some experts forecast that they might soar to three per cent this year.

Andrew Bailey

Bank of England chief Bailey issued a stark warning for Britain’s economic future (Image: Getty)

The only good news was for retirees, who are on track for 10 per cent pension rises under theGovernment’s triple-lock pledge. Mr Bailey expects the economy to fall into decline in the last three months of this year and to keep shrinking until the end of 2023.

He warned that the tough action of raising interest rates was needed now to prevent the cost-of-living crisis from becoming “even worse”.

Yesterday’s 0.5 per cent base rate rise – the sixth consecutive increase – is the sharpest hike in 27 years. The Bank is battling to stem soaring prices, with inflation – already at a 40-year high of 9.4 per cent – set to top 13 per cent in October.

Mr Bailey admitted the cost-of-living squeeze was difficult – but said the longest recession since the 2008 global crisis was about to grip the UK, with energy costs sent sky-high by Russia’s war on Ukraine.

A typical home’s monthly energy bill will be almost £300 by October.

Mr Bailey said he had “huge sympathy and huge understanding for those who are struggling most. I know that they will feel, “Well, why have you raised interest rates… doesn’t that make it worse?” It doesn’t – because I’m afraid the alternative is even worse in terms of persistent inflation.”

Analysts said borrowers with tracker mortgages are likely to have to find £50 more per month. Some experts see the Bank raising rates by another 0.5 per cent soon.

The recession – two or more straight quarters of decline – is likely to shrink the economy by 2.1 per cent. Karl Thompson, of forecasters the Centre for Economics and Business Research, warned: “Petrol pump prices remain significantly above levels seen prior to Russia’s invasion of Ukraine, and the [producers’] decision to increase oil output only moderately will work to keep prices high.

“Moreover, a significant further increase in the Ofgem energy price cap is expected this October, driven by higher prices for natural gas.

“I expect the Bank of England to raise rates by a further 1.25 per cent across its remaining three 2022 Monetary Policy Committee meetings.” James Smith, developed markets economist at banking giant ING, said there was a “strong possibility” that rates may rise again, to 2.25 per cent, next month.

Lenders quickly passed on yesterday’s rate rise to borrowers.

Greg Marsh, boss of cost-of-living site Nous.co, said: “On a typical mortgage of £250,000, a half-point rise in interest rates means payments will increase by over £700 [a year] for a typical family.

Petrol Pump

Petrol prices are predicted to remain high (Image: Getty)

“That comes on top of the 1.15 per cent increase we’ve already had since December. Homeowners on fixed-rate deals will be deeply concerned about this jump in costs when they come to re-mortgage.”

Adrian Anderson, director of finance specialists Anderson Harris, called yesterday’s rate rise a “significant blow” to struggling households: “There’s no end in sight. The key drivers of inflation are energy prices and supply chain issues which are out of our control.

“We have a mortgage interest rate ticking timebomb. Around 74 per cent of mortgages are currently fixed but these borrowers will be moving on to much higher rates at a time when many other outgoings have already increased.”

Rebecca McDonald, chief economist at anti-poverty campaigners the Joseph Rowntree Foundation, said: “Staggeringly high inflation is going to hit low-income families hard. We already know seven million of them are sacrificing food, heating, even showers.

“Many also took on credit to pay their bills and are falling behind. This will be much harder to pay off with higher interest rates. The next Prime Minister should immediately revisit the Government’s cost-of-living support.

“They must also increase basic Universal Credit entitlements to ensure that our social security system always, at a minimum, enables people to afford the essentials.”

Even taking into account help from the Government rising prices are expected to leave the average household poorer for two years. The Bank – which has an inflation target of just two per cent – said a typical yearly energy bill was likely to hit £3,500 in October.

Chancellor Nadhim Zahawi said: “We have been taking action to support people through these tough times with our £37billion package of help for households, which includes direct payments of £1,200 to the most vulnerable families and a £400 discount on energy.

“We are also taking important steps to get inflation under control through strong, independent monetary policy, responsible tax and spending decisions and reforms to boost our productivity.”

Prime Minister Boris Johnson and Mr Zahawi were both on holiday yesterday as the Bank of England warned Britain will be plunged into recession this year. Chief Secretary to the Treasury Simon Clarke was not in his office.

Mr Zahawi defended his absence, insisting: “For me…there is no such thing as a holiday and not working. Millions of us dream about getting away with our families but the privilege and responsibility of public service means that you never get to switch off. That’s why I have had calls and briefings every day.”

The Chancellor spoke to Bank boss Mr Bailey after rates rose. A Treasury source said Mr Clarke was in London and was working.

Nadhim Zahawi

Zahawi has defended his holiday during the current economic turmoil (Image: Getty)

Comment by Laith Khalaf – Head of investment analysis at AJ Bell

WINTER is coming, and it is shaping up to be an absolute horror show for the economy.

On top of the historic interest rate hike, the Bank of England’s frightening forecasts have shifted to a shocking extent in just three months. The UK economy is predicted to shrink by 2.1 per cent over the next year, more than double the 0.8 per cent contraction envisaged by the Bank as recently as May.

Economic trends do eventually tend to moderate and change direction, but it would be naïve to suppose that when the Bank produces its next economic report in November, we should not be braced for more bad news.

The next few months may well prove to be the calm before the storm – because summertime means we are not paying as much to heat our homes, and the recent popularity of fixed mortgage means homeowners will only feel the pinch of costlier interest payments when they roll off their current deals.

Higher interest rates are a vicious cure for inflation as they pile even more financial pressure on households already starting to struggle.

But they are the biggest weapon in the Bank’s armoury. If it hadn’t followed through with a 0.5 per cent rate rise with inflation set to rise to an expected 13 per cent, its credibility would have been shattered.

The Bank has also announced it will start selling the bonds it bought as part of the quantitative easing programme, putting further upward pressure on the cost of Government borrowing.

That is particularly relevant given the Tory leadership contest, in which inflation and tax cuts have taken centre stage.

UK politicians bear little responsibility for the current economic calamity, which is largely being driven by the after-effects of the pandemic and the war in Ukraine.

By the same token, they also have limited powers to solve these problems, especially since debt interest on UK borrowing is expected to be £87billion this year.

And while tax cuts of course sound appealing, businesses and homeowners might also find that what they get back in their pocket from lower tax is simply pilfered by higher interest payments.

The Bank takes tax policy into account when setting interest rates, and if it thinks government largesse is going to boost inflation, it will have to tighten monetary policy more aggressively.

It is an incredibly difficult situation, with no obvious solution.

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