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The Bank of England increases the key rate to 4% and warns that additional increases may be required

The Bank of England increases the key rate to 4% and warns that additional increases may be required

The Bank of England increased interest rates by a half point, stating that further rises would be required if signs of an inflationary spiral persisted.

The increase to 4% was approved by seven of the nine members of the Monetary Policy Committee of the UK central bank, while two abstained. The majority of respondents claimed that the economy’s pricing pressures were being fueled by robust pay growth and a persistent labour shortage. 

The key rate reached its highest level since 2008 as a result of the decision, which was the tenth hike since the BOE resumed raising rates in December 2021.

The economy is already in a recession, according to officials led by Governor Andrew Bailey, although it will last less time and be less severe than they had predicted in November. The risks associated with inflation are still “significantly weighted to the upside.” The committee cited this year’s unprecedented pay settlements.

The Bank of England’s prediction about GDP

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image source: Statista

The BOE predicted that the gross domestic product would fall by approximately 1% over the course of five quarters. The government of Prime Minister Rishi Sunak will have difficulties as a result of having to conduct elections by the beginning of 2025. According to the BOE, 500,000 additional employees will lose their employment before the economy reaches pre-pandemic levels of output, which won’t happen until at least 2026.

The BOE’s forecast of a contraction is nonetheless less severe than the 2.9% decline over eight quarters that was projected in November.

The BOE seems to support the market’s prediction that rates will peak at about 4.5% in the coming months, despite the gloomy overall picture. The panel stated that “additional tightening in monetary policy would be required if there were evidence of more sustained pressure.”

Right now, the market’s trajectory predicts rate reductions for 2019. The BOE withdrew its promise that it would react “forcefully,” which may be an indication that the cycle of rate increases is about to come to an end “if required.

The diversity of opinions regarding the MPC was a reflection of the difficulty in battling inflation, which is still hovering around a 40-year high and dealing with a bleak economic outlook.

Silvana Tenreyro and Swati Dhingra voted to maintain the status quo, arguing that the effects of earlier hikes had not yet fully materialized. Bailey and the majority of MPC members called for 50 basis points, and Catherine Mann, who previously voted in favour of a 75 basis-point rise, agreed.

The BOE reduced its forecast for the economy’s supply potential after observing that commerce was being negatively impacted by Britain’s exit from the European Union and that many people had left the labour market.

On the rate market’s projected trajectory, consumer price inflation is below the desired 2% level in two years. However, decision-makers advised against taking the forecast too seriously. “A projection for inflation that considered these potential upside risks was found to be significantly closer to the 2% target, “added the committee.

The BOE reduced its forecast for potential output, which represents the economy’s maximum rate of growth for the next three years, from 0.9% in November and from 1.5% at its most recent “supply stock take,” to 0.7% “fifteen months ago The trend rate was 2.5% before the financial crisis, and it was roughly 1.5% in the ten years leading up to the epidemic.

The bank attributed the economic downturn to a number of factors, including Brexit, the pandemic, and the rise in energy prices. It specifically mentioned labour scarcity, weak company investment, and low productivity.

The cost of Brexit remains the same economically, but the BOE now thinks more of the effects would be felt immediately. It reaffirmed that because the UK left the EU free-trade area, “the level of productivity would be roughly 3.25% lower in the long run.”

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