Britain’s economy is now in recession, the Bank of England has said, as it raised interest rates to tackle the worst bout of inflation for 40 years.
A majority of the Bank’s nine-member monetary policy committee (MPC) voted to increase the key base rate by 0.5 percentage points to 2.25% – its highest level since 2008 – judging that the risks of inflationary pressures becoming entrenched outweighed the short-term dangers to the economy.
With soaring energy bills and the rising cost of a weekly shop forcing households to rein in their spending, Threadneedle Street said the economy was heading for a second consecutive quarter of falling output.
After a 0.1% drop in gross domestic product in the three months to June as the economy slumped into reverse, the Bank said a further 0.1% decline could now be expected in the third quarter amid a slump in consumer spending and weaker activity for manufacturing and construction.
It said the fall also reflected a smaller-than-expected bounce back from the additional bank holiday for the Queen’s platinum jubilee, as well as the impact from businesses closing their doors in a mark of respect for the state funeral this week.
Three members of the MPC voted for an increase of 0.75 percentage points, five supported a half-point increase and one pushed for a more limited quarter-point move.
The City had been braced for at least a half-point increase, with financial markets betting on a rise of 0.75 percentage points to match the sharp increase from the Federal Reserve on Wednesday as the US central bank pushes to squeeze inflation out of the world’s largest economy.
Three members of the MPC – Dave Ramsden, one of the Bank’s deputy governors, and the external members Jonathan Haskel and Catherine Mann – pushed for a tougher 0.75 point increase owing to mounting concerns about inflation becoming entrenched.
The majority of the MPC, including the Bank’s governor, Andrew Bailey, voted for a half-point increase, while the rate-setting panel’s new external economist, Swati Dhingra, pushed for a smaller quarter-point rise in reflection of concern over the deteriorating strength of the economy.
The decision comes a day before the chancellor, Kwasi Kwarteng, announces the details of the government’s energy price guarantee and a package of sweeping tax cuts expected to cost more than £150bn to kickstart economic growth and shield households from soaring bills.
The Bank said the energy price guarantee would act to prevent a higher peak for inflation, with the headline rate expected to peak just below 11% this autumn. Although the consumer prices index eased slightly from 10.1% in July, reaching 9.9% in August, it remains at a level not seen since the early 1980s and is almost five times the Bank’s 2% target rate.
However, the Bank warned the impact of the government’s support measures risked adding to inflationary pressure. “While the guarantee reduces inflation in the near term, it also means that household spending is likely to be less weak … this would add to inflationary pressures in the medium term.”
In a further move to tackle inflationary pressures, the Bank announced it would start actively selling £80bn of UK government bonds bought under a quantitative easing scheme used since the 2008 financial crisis to support the economy. It aims to reduce its portfolio of gilts to £758bn over the next two years.