Bank raises rates too late as UK heads towards recession

Few failed to predict that the Bank of England’s Monetary Policy Committee would raise rates today. Commentators were split on whether the rise should be 25 or 50 basis points and the 6-3 split on the Committee suggests it reflected the same range of views.

So no surprise then.

More interesting is the Bank’s new forecast. It now forecasts double-digit inflation in the autumn and zero growth (which almost certainly means recession) in the four quarters to Q2 2023. The forecast is now very similar to that produced by my Cebr colleagues two months ago in reaction to the invasion of Ukraine, though the Bank’s forecast inflation peak is now very slightly higher than my colleagues’ prediction.

Some have criticised the interest rate rise as too little given past inflation. It is certainly true that with inflation eroding the value of assets at coming up for 10 per cent a year, a paltry 1% cost of money won’t discourage borrowing. But the proper measure of real interest rates (at least as an operational tool) is the comparison of the current cost of borrowing with the expected move in asset prices.

Here, borrowing may not look so cheap. It is hard to see house prices continuing to rise into all the headwinds of the current economic situation unless the Ukraine position is magically transformed. Equities look likely to continue to slide. Bonds, having already been routed in recent weeks, might just hold up.

The latest official data already shows that 12-month monetary growth (M4) has slowed from a peak of 13.7 in February 2021 to 5.4% in March 2022.

With public borrowing also falling very sharply, partly because of the impact of inflation on the erosion of tax thresholds and allowances, it does look as though the country is going into recession with both the Treasury’s and the MPC’s feet hard on the brakes.

We were unlikely to emerge from the inflationary consequences of supply shortages, the resurgence of the pandemic in China and then the Ukraine war without the economy suffering considerable pain. But it does look as though the authorities have mistimed their tightening – they failed to end furlough early enough and then have raised taxes too much this year.

Now the MPC may be compounding the effects this by raising interest rates too late.

Douglas McWilliams is Deputy Chairman of Cebr, the economics consultancy.