The group also warned that Britain would enter a recession by the last quarter of 2022, pointing to spiking energy prices that have weighed on Europe’s economy since Russia invaded Ukraine earlier this year. They signaled that inflation will likely worsen before it gets better and projected that the contraction will be lasting, with inflation-adjusted household income falling sharply this year and next.
“The latest rise in gas prices has led to another significant deterioration in the outlook for activity in the United Kingdom and the rest of Europe,” the bank wrote in its announcement.
Fed’s interest rate hikes may mark start of tough new economic climate
Oil prices slid more than 2 percent Thursday as markets grappled with the likelihood of a recession, which could slash energy demand. West Texas Intermediate crude, the U.S. benchmark, fell below $90 per barrel for the first time since the Russian invasion in February. Brent crude, the global benchmark, was down below $94 per barrel.
“The headline from the Bank of England is just the latest macroeconomic warning,” said Pavel Molchanov, an analyst with Raymond James. “The weaker the economy, the less growth in oil demand, all else being equal. These macroeconomic fears are canceling out the fact that the war continues to drag on, and Russia’s energy sector faces escalating pressure.”
Thursday’s decision is the latest effort from global policymakers to put a lid on rising prices ― something that has forced sweeping policy changes on both sides of the Atlantic.
Central banks in the United States and Europe held rates near zero in 2020 and 2021 to spur their pandemic-ravaged economies into recovery mode, but were forced to shift their approach in 2022 when inflation became a dominant economic concern.
Prices have surged throughout Europe as in the United States, driven in part by the Russian war, which has disrupted energy markets on which many parts of Europe depend. Higher prices throughout the 19-nation euro zone, of which Britain is no longer a part of, reached 8.6 percent in June, the highest level in decades, prompting the European Central Bank to raise interest rates by half a percentage point last month.
In Britain, inflation is even higher, reaching 9.4 percent in the 12 months ending in June, driven by higher energy and food prices.
The Bank of England rate hike follows one announced last week by the Federal Reserve, which has been raising rates at a faster clip. The U.S. central bank has raised rates four times since March — including by 0.75 percent on July 27 — and has signaled that more will follow in an ongoing effort to rein in inflation. Higher rates also makes borrowing more expensive, slowing down business investment, home-buying and debt-fueled transactions more broadly. But some experts worry the strategy could set off a recession as economies slow down.
The changing shape of inflation
The Bank of England wants to cut the rate of inflation to 2 percent, but policymakers believe prices could worsen before they improve. It projects that Britain’s consumer price index will rise higher than 13 percent in the fourth quarter of 2022 and remain at “very elevated levels” through 2023.
The price increases in Britain have been more pronounced than those in the United States. The U.K. consumer price index hit a 40-year high in June, jumping 9.4 percent year over year. The May reading was a 9.1 percent jump. Housing has become even more expensive there, along with electricity, gasoline, motor oil and other fuels.
In both the United States and Britain, inflation has become a political dragnet with few obvious solutions.
President Biden called it “the bane of our existence” during a June appearance on Jimmy Kimmel’s late-night talk show, and its impact on Democrats’ priorities can be seen in their decision to name their signature economic bill the “Inflation Reduction Act,” as opposed to the long-stalled Build Back Better bill.
In Britain, the central bank’s pivot threatens to intensify political tensions as the Conservative Party chooses a new leader to replace outgoing Prime Minister Boris Johnson.
“If you look at the British economy,” said Quincy Krosby, chief global strategist at LPL Financial, “the upper wage earners can handle the higher costs more easily … but they are typically the largest contributors to consumer spending.”
Such kitchen-table issues bring out the voters. “What you start to see is anger, as the average citizen just say, ‘this is falling on my shoulders,’” she said.
Thursday’s announcement also made clear that central bankers are prioritizing price stability over economic growth, with hints that more aggressive action might be needed if inflation worsens.
The monetary policy committee “will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit,” bank policymakers wrote, later adding that it will be “particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response.”
Bank of England Governor Andrew Bailey doubled down on that position in a news conference Thursday, adding that inflationary pressures appear to be becoming more persistent and are broadening to more parts of the domestic economy there.
“Returning inflation to the 2 percent target remains our absolute priority with no ifs or buts about it,” he said.
Major economies in Asia are being more cautious about raising interest rates. The Bank of Japan still maintains ultralow rates as the nation’s economy recovers from the pandemic and worsened terms of trade. The bank doubled down its commitment to fight against deflation by keeping its yield curve control — maintaining the yields on 10-year government bonds around 0 percent with 25 basis points. In June, the Japanese yen fell to the lowest rate in two decades.
The People’s Bank of China lowered borrowing rates in May in an attempt to revive its housing market and consumer spending, following months of lockdown in the country’s financial hubs. Inflation, Krosby said, is closely tied to risks of public unrest.
“The one thing that Beijing does not want is to have food prices skyrocketing because the leadership does not want turmoil,” she said.