The economy is at greater risk of falling into recession next year as investors expect interest rates to rise to the highest level since 2000 in an effort to suppress inflation.
The Bank of England surprised by raising the interest rate by half a point, as financial markets expect at least three more increases before the end of the year to force inflation to decline. Money markets expect borrowing costs to peak at 6.1 percent by the end of the year, a level at which economists have warned that tightening would push the economy into contraction.
George Buckley, chief UK economist at Nomura, said there was now “a greater risk that, in Milton Friedman’s words, the Bank will end up being a ‘fool in the shower’ and rising too much, requiring a quick correction in the event of a recession.” “.
Andrew Bailey, the bank’s governor, said the anti-inflation crackdown was not intended to “precipitate a recession… We have a much stronger and more resilient economy than we expected it to be. Part of that is because energy prices are much lower, which is good news. So we We neither expect nor desire a recession. But we will do what is necessary to bring inflation down to the target.”
The Bank’s Monetary Policy Committee warned that inflation will not decline as quickly as it jumped last year, as wage growth and prices of goods and services rose much more than the Bank expected in recent months.
Bailey has come under fire from critics for being too optimistic about the risks of high inflation becoming embedded in the economy. The bank’s base interest rate has been raised from 0.1 percent to 5 percent over the past 17 months.
There was a muted market reaction to the interest rate decision, as UK government bond prices fell slightly and the British pound lost 0.2 percent against the dollar to $1.27. Bonds become less attractive to bondholders in an environment of rising interest rates, as high inflation reduces the real value of the coupons for investors.
The FTSE 100 closed down 57.15 points, or 0.8 percent, at 7,502.03, and the FTSE 250, a better reflection of the UK economy, fell 1.3 percent, or 243.48 points, to 18,327.97.
Lee Hardman, a currency analyst at MUFG, the Japanese bank, said the pound could weaken further if the country’s growth prospects soften. Britain has avoided recession this year, but is barely achieving growth above zero percent. If growth holds and dollar weakness continues, Hardman said, the pound could touch $1.30 this year.
There are initial signs that inflationary pressures are beginning to ease and the economy is slowing. A measure of producer price inflation fell to a two-year low last month, indicating that business costs are no longer rising at a rapid pace. There is also evidence that banks and lenders are starting to tighten consumer credit and households are beginning to deplete savings built up during the pandemic.
