The Bank of England’s (BoE) efforts to rein in soaring inflation may inadvertently lead the United Kingdom into a recession by the year’s end. This anticipated downturn is seen as a necessary sacrifice in the battle against an inflation rate that stubbornly remains at levels unparalleled among the Group of Seven economies.
Despite the Bank’s concerted efforts, which include implementing a series of 13 interest rate increases since the conclusion of 2021, the inflation rate continues to hover perilously close to the daunting double-digit mark, according to an analysis by economists Dan Hanson and Ana Andrade, as reported by Bloomberg Economics on June 27.
The assessment sheds light on the delicate balancing act the central bank faces when addressing inflationary pressures. While high inflation erodes purchasing power and burdens consumers, it also poses a formidable challenge for policymakers. The Bank of England’s relentless interest rate hikes have been aimed at curbing inflationary expectations, but their impact has thus far fallen short of desired outcomes.
The rationale behind the projected recession lies in the Bank’s unwavering commitment to taming inflation. To effectively address the persistent and high inflation, a protracted downturn is viewed as an inevitable consequence. By navigating the economy through a shallow recession, policy authorities aim to exert control over the soaring inflation and bring it back within acceptable bounds.
A year-long recession
If the Bank of England raises interest rates to 5.75% by November as planned, then the United Kingdom will enter the last three months of this year in the midst of an economic downturn that will last for a year. In the run-up to the next election, there would be a brief period of economic contraction, amounting to a loss of little over one percent of total production.
“The risk is the data continues to prove unresponsive to the BoE’s actions and interest rates rise further than our baseline. As borrowing costs move above 5%, we think the risk of a financial stability shock increases exponentially,” Hanson and Andrade said.
The economists added:
“What that estimate could easily miss is the possibility that the lags from past tightening are longer than we have assumed or that high rates create financial instability. Should either of those scenarios play out, the recession would be significantly deeper.”
The 0.3% increase predicted by Bloomberg Economics has been sharply reduced to a 0.1% expansion this year and a 1% contraction in 2024.
That’s if the Bank of England hikes interest rates from their current 5% to 5.75% by November. Nonetheless, 6.25 percent by December is virtually entirely priced in, increasing the risk of a far worse downturn.