The Bank of England is expected to maintain its interest rates at a 15-year high in the face of ongoing inflationary pressures, despite growing signs of strain in the UK economy. With British inflation remaining the highest among wealthy nations, the Bank’s previous 14 consecutive interest rate increases, implemented between late 2021 and August of this year, have begun to impact the housing market, employment, and consumer spending.
Consumer price inflation in the UK reached 11.1% in October 2022, surpassing comparable economies, and has been slow to decrease. September saw a slight decrease to 6.7%, although service price inflation, which is closely monitored by the Bank of England, increased. Governor Andrew Bailey has stated that these figures were in line with the Bank’s expectations. Economists predict a significant decline in headline inflation in October as last year’s energy price surge will no longer be a factor in the comparison. However, the Bank of England’s forecast in August indicated that inflation would only return to its 2% target in the second quarter of 2025. New forecasts are set to be released on Thursday.
While pay rises have eased slightly, official data suggests that they remain at their fastest pace in 22 years. There are indications that the jobs market is cooling, such as slower growth in starting pay for individuals hired through recruiters. However, assessing the labor market has become more challenging due to issues at the UK’s statistics office in conducting its surveys.
The surging costs of mortgage borrowing have negatively impacted the housing market. This sudden increase in costs has led to a significant slowdown in transactions and borrowing for house purchases, further weighing on the broader economy. It’s worth noting, however, that house prices have fallen by approximately 5% since September, compared to their 25% surge from the start of the pandemic to its peak.
Consumer spending has also been affected by inflationary pressures. The volume of goods purchased at retailers dropped by almost 1% in the three months leading up to September. This decline, the first since early 2023, cannot be entirely attributed to unseasonable weather. Economists suggest that this weak data increases the risk of the UK economy contracting in the third quarter of 2023, potentially signaling the beginning of a recession. Additionally, a measure of consumer confidence sharply fell in October due to the cost-of-living squeeze burdening households.
Despite these challenges, the Bank of England is anticipated to maintain its high interest rates as a means to combat inflation. In August, the Bank expressed its intention to keep rates elevated to ensure inflation is reduced. Chief economist Huw Pill has likened the economic outlook to the flat and lengthy summit plateau of Table Mountain. Currently, financial markets do not foresee a more than 50% chance of the Bank of England reducing the Bank Rate until August 2024. By comparison, the markets expect the United States to implement its first rate cut in June, with the European Central Bank expected to lower borrowing costs earlier than the Bank of England.
In conclusion, the Bank of England faces the challenge of balancing high inflation with the need to avoid a recession. With inflation exceeding the Bank’s target and showing slow declines, the housing market experiencing a slowdown, and consumer spending being squeezed, the Bank’s decision to maintain high interest rates is aimed at tackling inflationary pressures. However, the potential risks of a contracting economy and declining consumer confidence pose additional challenges that the Bank must navigate.
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