The Bank of England raised interest rates by half a percentage point on Thursday, the largest jump since 1995, as policymakers strengthened their efforts to tackle inflation even as they warned Britain was heading into a long recession later this year.
The bank raised rates to 1.75 percent, the highest since 2008, from 1.25 percent as it forecast the annual rate of inflation would climb above 13 percent when household energy bills jump higher in October. That would be the highest level of inflation in 42 years.
Much of the surge in prices is still coming from the global energy market, the bank said. In the past three months, wholesale natural gas prices for this winter have nearly doubled, which is expected to lead to the price cap on household energy bills reaching 3,500 pounds (about $4,260) in the fall, three times higher than bills were a year ago, the bank predicted.
The outlook for millions of British households is grim. Incomes, once adjusted for inflation and taxes, are predicted to fall sharply this year and next, in the worst decline in records dating to the 1960s.
Britain will enter a recession in the last quarter of this year that will last through to the end of 2023, the bank forecast.
“The latest rise in gas prices has led to another significant deterioration in the outlook for activity” in Britain and the rest of Europe, policymakers said, according to minutes of this week’s meeting. Britain “is now projected to enter recession.”
The rate change announced on Thursday was the sixth increase since December as the bank tries to tackle inflation, which is running at its fastest pace in four decades. It has been under some pressure to increase rates by more than its usual quarter-point move as inflationary pressures persist and other major central banks also take more aggressive action to halt price increases.
The Bank of England was the first major central bank to start raising rates in response to the global inflation fight and reining in monetary policies that supported economies during the pandemic. The European Central Bank last month raised interest rates for the first time in more than a decade. And in the United States, the Federal Reserve last week raised rates by three quarters of a percentage point for the second straight month.
There is little the banks can do to slow energy prices or ease supply chain disruptions, but their goal is to make sure rapid price rises do not last too long by making it more expensive for consumers and businesses to borrow money. So far unemployment has remained generally low in the United States, Europe and Britain, but the risk is that in trying to bring down inflation, policymakers will cause deep downturns and layoffs. The International Monetary Fund warned last month that a global recession could be at hand.
Global inflation has been exacerbated by the war in Ukraine, and the Western sanctions imposed on Russia that have further interrupted supply chains and driven up the cost of energy.
“There is an economic cost to the war,” Andrew Bailey, the governor of the bank, said on Thursday. “But it will not deflect us from setting monetary policy to bring inflation back to the 2 percent target.”
The National Institute of Economic and Social Research, a London-based think tank, said on Wednesday that the economy was entering a recession in this quarter and would lose 1 percent of gross domestic product over three quarters.
“We’re really in stagflation here,” Stephen Millard, the deputy director of the research institute, said before the bank’s decision. As high inflation meets a recession, household incomes are being squeezed because pay growth isn’t keeping up with rising prices. The research institute has called for more government support to low-income households as food prices continue to rise and household energy bills jump, perhaps by as much as 75 percent in the fall.
The Bank of England’s own forecasts are even gloomier. Next year, the economy will contract 1.5 percent, it predicted. It shows the scale of the economic challenge facing the two Conservative lawmakers battling for the party leadership and role of prime minister. Much of the debate so far has centered on taxes, with Liz Truss, the front-runner, vowing to quickly cut them for workers and businesses amid a cost of living crisis.
Even as the economic outlook worsens, the central bank has emphasized its primary goal in bringing down inflation. Eight of the nine members of the rate-setting committee voted for the outsize move amid signs that inflationary pressures were becoming more persistent and emerging in more parts of the economy.
“The mix of high near-term inflation and weak activity leading up to a recession, is a challenging backdrop for monetary policy,” but the focus must remain on inflation and inflation expectations, Mr. Bailey said.
The inflation picture has deteriorated rapidly. In December, when the bank first raised rates, it predicted inflation would peak at 6 percent in April. Now that peak is six months later and more than twice as high. Higher energy prices are a primary reason for the rapid inflation, the bank said, but supply chain disruptions and domestic inflation pressures are also rising.
Inflation for consumer services, which are much less affected by the global price of goods, was up 5.2 percent in June from a year earlier, the highest since early 1993. The tight labor market is also pushing up inflation. Unemployment is low and job vacancies are high, so underlying wage growth is rising as employers compete to hire and retain staff. Meanwhile, companies are passing along a larger share of their cost increases on to their customers.
Even though some contributors to inflation are showing signs of easing, such as global commodity prices, policymakers took only limited comfort from these signals. There is a risk that a longer period of inflation generated by external factors, such as global energy prices and pandemic-related supply chain disruptions, will lead to “more enduring” price and wage pressures at home, the minutes said. This was one of the reasons for the larger-than-usual interest rate increase.
But with so much uncertainty about the economy and prices, the bank offered fewer hints about the future path of interest rates.
“Policy is not on a preset path,” the minutes said. “The scale, pace and timing of any further changes” in interest rates will be dependent on the committee’s assessment of the economy and inflation.