The economic picture painted by the Bank of England for the years to come was relentlessly bleak. A long recession, high inflation, falling living standards: it would be hard to find a worse set of conditions for a government before legislative elections.
Threadneedle Street was the subject of much criticism even before announcing its latest grisly predictions. He cannot expect any respite now, as the government will have to find a scapegoat to blame for the misery to come.
And there could be many. The fact that the Bank’s monetary policy committee raised interest rates for a sixth straight meeting came as no surprise. More surprising was the pessimistic nature of the predictions that accompanied the MPC’s decision.
Inflation is now expected to peak at 13.3% in October – its highest since September 1980 – and will still be close to 10% a year from now. The economy will start to contract in the last three months of this year and won’t start to grow again until early 2024. Living standards will fall by 5% over the next two years – a drop not seen since the start of the modern records in the early 1960s.
In this context, the MPC raised interest rates by 0.5 percentage point to 1.75%. Not only was it the biggest increase in the official cost of borrowing since 1995, but it was also the first time the committee raised rates while forecasting a recession.
Eight of its nine members voted for a 0.5 point increase, on the grounds that the labor market remained tight and there was a risk of entrenched inflation. But the labor market is unlikely to remain strong for long: the Bank believes that a recession, which is expected to last as long as those of the early 1980s and late 2000s, will push unemployment from below 4% to well over 6% by 2025. Longer queues and higher interest rates will lead to a marked cooling of the housing market.
The forecast is based on two assumptions: that the financial markets are right to believe that interest rates will peak at 3% and that there will be no more government support for struggling households. Both are debatable. Some analysts believe the economy is so weak that the Bank will stop tightening after one or two more rate hikes. There will definitely be more help with energy bills this fall, whoever the premier is.
Politically, the Bank has rarely been in a more difficult position. A year ago, he thought inflation would peak at 4%, but he has steadily raised his forecast since. Andrew Bailey, the Bank Governor, dismissed criticism that the MPC had fallen asleep at the wheel and were now hitting the brakes at exactly the wrong time. It says rising energy prices – which alone accounts for half of the 13% annual inflation rate – and global supply chain bottlenecks are responsible for most of the ‘increase.
Bailey said the pain was inevitable, but would be worse if the Bank allowed inflation to take hold. The MPC’s warning that it will be “particularly attentive to indications of more persistent inflationary pressures” means another half-point hike is possible next month.
Both Conservative leadership candidates said the Bank’s forecasts supported their economic plans: in Rishi Sunak’s case, reducing inflation was the number one priority; in the case of Liz Truss, that tax cuts were needed to stave off the recession.
Truss, the favorite to replace Boris Johnson as prime minister, has openly criticized Threadneedle Street. At the very least, she would order a review of the Bank’s mandate – the legal obligation to meet the government’s 2% inflation target – but she hinted that she was going further. For the first time since Gordon Brown granted it the freedom to set interest rates in 1997, the Bank’s independence seems threatened.