Why the UK’s Sluggish Growth Rate Is Too Much for the BOE

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(Bloomberg) — Britain’s economy is heading toward a period of faltering growth above the threshold of recession, but for now, even the tentative pace of expansion is sounding alarm bells at the Bank of England.

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The BoE is keen to bring double-digit inflation back to its 2% target and has estimated that the economy can only grow at a dismal pace without adding upward pressure on prices.

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Gov. Andrew Bailey and his colleagues signaled last week that the fastest streak of price rises in four decades may be coming to an end, but they remain on guard against signs that wages and prices will continue to rise. A more resilient economy and a stronger-than-expected job market threaten to make the job even harder.

Investors are still factoring in the strong chance that the key rate, now 4.5%, will reach 5% by the end of summer.

Here are the main charts showing the UK outlook:

While the Bank of England’s Monetary Policy Committee has delivered the biggest ever upward revision in growth forecasts, officials still expect UK expansion to follow the US and the eurozone.

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The outlook is a sharp improvement from the February forecast for a prolonged recession. But growth is expected to be very slow, slowing to 0.25% this year and only rising to 0.75% in both 2024 and 2025. At this pace, production won’t recover to pre-pandemic levels until the end of 2023 – roughly four years after Covid infection for the first time.

“It’s a very big upward revision, but the growth level is still weak, let’s be honest,” Bailey said last week. These expectations are still not strong. We still expect some degree of recession to emerge at the end of this year.”

Fresh GDP figures on Friday highlighted Britain’s struggles to sustain growth, which puts the UK at the bottom of the Group of Seven nations.

Worryingly, there are signs that the resilient British consumer is struggling under the weight of rising borrowing costs and the cost of living crisis. Monthly data for March showed a contraction of 0.3%, driven in part by weak consumer-oriented services. It meant that the UK achieved only the smallest measure of growth in the first quarter.

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Even recovering from anemia is a risk for Billy.

While energy and food prices have pushed inflation into double digits, it is now domestic drivers, including a looser economy and a tougher-than-expected labor market, that are adding to price pressures. The Bank of England expects the economy to be 2.25% larger in mid-2026 than it thought in February, creating additional demand that could keep a fire under prices.

For now, the Bank of England expects a rapid drop in inflation starting this month when the April figures are released. The current rate of 10.1% could drop to just over 5% by the fourth quarter – already lower than in the US.

Bailey and chief economist Huw Bell said they are watching the data for so-called second-round effects of inflation, when rising prices in one part of the economy causes others to raise them as well.

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Bailey cautioned that these effects are unlikely to “disappear as quickly as they appeared”, with the MPC focusing on wages and service-sector prices for clues about how long the increases will last. So far, Bailey said the news has been “mixed.”

One factor dampening inflation is the slow but increasing effect of higher rates on homeowners. The Bank of England believes that a third of the rate hikes delivered so far have spilled over to affect mortgage holders. Many are set to feel the pain of higher borrowing costs when their fixed-rate deals expire.

UK households have moved to protect themselves by taking out long-term mortgages, delaying the moment when they have to fix the cost of their loans at a higher rate. The Bank of England estimates that 1.3 million households will feel the pinch this year.

This, along with the high rate of inflation, has put pressure on the purchasing power of households, which may contract in the next few months. This pain for consumers may reduce the Bank of England’s inflationary pressures – but it will increase risks to economic growth.