The Bank of England has delivered its biggest interest rate rise in more than three decades as it warned of the longest recession on record.
The economic downturn, which is thought to have started this summer, will last until mid-2024, according to the central bank. It will be longest recession since the First World War but it will not be as deep as the downturn that followed the financial crisis of 2008.
Interest rates have risen by 0.75 percentage points to 3 per cent in the biggest single rate rise since 1989 as the central bank battles double-digit inflation.
Officials said the looming recession will be longer than expected because of the impact of the recent sell-off of UK assets on the cost of government borrowing. Investors’ forecasts for yields on government bonds, which are taken as a measure of the cost of public borrowing, have risen for the next few years.
The recession is expected to knock 2.9 per cent off the size of the economy, which is less than half of the 6.3 per cent decline in output that followed the financial crisis.
Inflation, which hit 10.1 per cent in September, is expected to peak at 11 per cent this winter before falling next year. Further interest rate rises are on the way, but they are unlikely to go as high as investors’ predictions of 5.2 per cent, rate-setters said in the minutes of their meeting this morning. The Bank’s inflation target is 2 per cent.
Giles Coghlan, Chief Market Analyst, HYCM, said: “Today’s decision from the Bank of England will come as no surprise to the markets, which had already priced in a 75bps hike and forecasted a peak of 4.75% in August next year. In line with consensus, the hike comes as the markets have been restored to some degree of calm following the departure of Liz Truss and her large package of fiscal borrowing against spiralling inflation.
“For now, at least, Rishi Sunak’s elevation to PM has instilled some sense of stability in the gilt markets and the wider economy, which has made the Bank of England’s decision easier today. This was reflected in the fact that the Band Of England now expect to raise interest rates to a lower peak than was previously priced into markets. This will be welcome news to UK homeowners about to renew their mortgages. The impact of the Energy Price Guarantee is seen by the BoE as reducing inflationary pressure to 11% for 2022 Q4 (down from August’s projections), so this will in part be why the BoE see the need to raise rates to a lower terminal rate. The BoE see inflation falling back early next year and back down to 2% in 2 years time.
“The other reason the BoE need to do less is that the fiscal side of things will see more tightening on household budgets. All eyes will now turn to the new prime minister’s first budget on the 17th of November as it will be the biggest factor in determining both the path of the Bank of England’s interest rates and the direction of the GBP.
“It is also worth noting the influence that the Federal Reserve’s meeting on Wednesday has on the GBP. With the Fed revealing that they see higher than originally thought interest rates ahead, it’s too early to call a definite peak in the USD. With this in mind, hopes of a rescue for the GBP from the US must be postponed for a little while longer, as further USD strength will continue to pressure the GBP. Today’s hike is gently GBP negative from the BoE, so the GBP should be pressured today.”
Jatin Ondhia, CEO, Shojin added his thoughts : “There’s no longer any great shock in the Bank of England’s course of action, but we must prepare for the after-effects. Most obviously, while the signs suggested that the property market was already feeling the effects of rising interest rates, this latest, more significant jump, will certainly have an impact.
“As the cost of borrowing climbs sharply, people’s chances of getting onto or moving up the property ladder will diminish, while traditional property investments, like buy-to-lets, will likely become less attractive. We could see people pursue alternate forms of real estate investment, including fractional investment into developments.
“I would expect investors to consider the assets and markets they are backing right now, with diversification a logical route for many during times of high inflation and rising interest rates. Alternative investments could become more popular, with investors potentially seeking to balance higher-risk options that could better keep pace with inflation at the same time as still gravitating towards safe haven assets.”
Commenting on the announcement, Tasha Chouhan, UK & IE Banking and Lending Director at Tink said: “Interest rates skyrocketing to heights not seen since the 2008 financial crisis means the scramble for the best credit deals is set to become increasingly competitive. Coupling this with soaring mortgage rates limiting buying power, and the BoE’s latest data around the fall in mortgage approvals, the need for more robust and inclusive creditworthiness assessments to support consumers has never been more evident.
“Yet, our research shows that 50% of lenders are still using outdated and limited credit scoring models – potentially excluding millions of people from credit who can afford it.
“There is no place for such models in our current economic climate, and the sooner this is recognised, the better the outcome will be for both lenders and consumers. We need to move away from outdated lending models to unlock fairer, more inclusive affordability checks. New forward looking models can draw on technology that enables people to use the data in their bank account to provide a real-time, holistic view of their income and affordability. It’s vital to protect potentially at risk or vulnerable consumers from problem debt or default as the economic climate worsens. At the same time, data-driven affordability checks are key to promoting financial inclusion, as people now more than ever need access to safe, affordable borrowing options.”
