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UK facing ‘toxic economic combination’

UK facing ‘toxic economic combination’

The Bank of England is facing difficult policy decisions as the UK economy grapples with inflation and a recession, experts have said.

The UK central bank today (May 5) raised interest rates 0.25 percentage points to 1 per cent, after inflation hit 7 per cent last month.

Six members of the MPC voted to raise rates to 1 per cent, with three members preferring a higher raise, to 1.25 per cent.

Luke Bartholomew, senior economist at Abrdn, said the divisions reflect just how difficult it is to set policy at the moment.

“The BoE has revised its inflation forecasts higher, while it is now expecting a small contraction in the economy in 2023. 

“This is a toxic economic combination, which requires the bank to make difficult trade-offs over how much it prioritises supporting growth or bringing inflation down.”

Part of the division in the MPC can therefore probably be accounted for by different policy makers assessing this trade-off slightly differently, he said, adding that it makes it hard to extract a clear signal from the bank about where interest rates will settle.

The BoE’s monetary policy committee also warned that it cannot prevent the ongoing squeeze on households caused by high energy and food prices.

Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said the MPC’s prediction that inflation will shoot up to 10 per cent in the autumn is “frightening”.

“The stage is set for a pretty bleak winter of discontent with the economy heading into reverse and little end in sight to rising prices given the ongoing toll the war in Ukraine is having on commodity markets,” she said.

Steven Bell, chief economist at BMO Global Asset Management, said the predicted recession is the result of interest rates being cut to emergency levels during the pandemic.

“That emergency is now over in macroeconomic terms but [central banks] have been slow to restore interest rates to more normal levels."

The Bank of England may have felt that they faced a difficult decision today as it attempted to balance weaker growth prospects against surging inflation, he said.

“The reality is that interest rates remain too low, throughout most of the developed world, and that dilemma is only set to get worse in the coming months.”

Tom Bill, head of UK residential research at Knight Frank, said the base rate increase will not by itself have an impact on house prices but will contribute to a slowdown that appears to be underway. 

“Growth will calm down as the cost-of-living squeeze gradually takes it toll on demand and mortgage lenders continue to pull their best products from the market,” he said. 

The other key consideration is supply, which has had the single biggest impact on house prices this year, he added. 

“As it rises, the double-digit house price growth that has taken most people by surprise during the pandemic will return to earth.”