UK experiencing the worst hit to household spending power for 30 years

The governor of the Bank of England tells Economics Editor Joel Hills that if companies award inflation-busting pay increases then the cost of living crisis will get worse

One of the economic anomalies of the last two years has been that, while we have been trying to recover from the deepest recession in 300 years, the housing market in most parts of the UK has been booming.

There are several reasons why house prices took off but first among them is that interest rates have been extraordinarily low.

The weather appears to be changing.

On Thursday morning, the Bank of England raised Bank Rate - the Bank of England base rate which influences commercial bank interest rates - for the second time in three months to 0.5%. It’s the first back-to-back rise since 2004.

Two million households in the UK will immediately see their monthly mortgage repayments rise.

According to UK Finance, the average tracker deal will go up by £25.76 per month.

The Bank of England is signalling there will be more to come.

The Bank of England has increased its Bank Rate Credit: AP

The Bank has moved to contain inflation which is running much, much hotter than it expected.

Energy bills are set to surge again in April, supply chain bottlenecks continue to push up the price of goods.

The Bank now expects the headline rate of inflation to peak at 7.25% in April (the highest level since August 1991) before easing back to 5% in a year’s time.

The Bank’s is supposed to be targeting an inflation rate of 2%.

'We have to use our tools to prevent this getting worse,' Bank of England Governor Andrew Bailey said as he acknowledged that the poorest households will be hit hard by energy bill increases

Higher interest rates are not designed to make gas and electricity cheap or bring down shipping costs.

The Bank is making borrowing more expensive because it is concerned that rising prices are putting upward pressure on pay, which could in turn leads to higher prices.

Unemployment is low, the economy is awash with vacancies. The labour market is tightening and the danger is that inflation, which to-date has been largely imported, may start to be generated domestically.

The Monetary Policy Committee (MPC) voted by a majority of 5-4 for the 0.25% increase. Those in the minority thought the increase should have been larger. The MPC advises “Some further modest tightening in monetary policy [is] likely to be appropriate in the coming months."

Markets are betting on an further three interest rate increases this year.

Why raise interest rates at this moment?

Sterling overnight rates suggest Bank Rate could reach 1.5% by the start of 2023 - that’s low by historical standards but a chilling thought for estate agents.

Bank Rate at that level would add another £103.03 to the average monthly repayment on a tracker deal.

1.5 million homeowners with fixed-rate deals will also have to remortgage at some point this year.

A latte, which currently costs around £3.32, could shoot up to £8.49 by 2050. Credit: PA

As ever, forecasting is nothing more than educated guesswork. We have no idea how events will unfurl but the Bank seems to have formed two assumptions with some confidence:

Firstly, that the economic growth from Omicron will be “limited and short-lived” and the UK economy will, once again, return to its pre-crisis size by the end of March.

Secondly, and more troubling, is the judgment that the squeeze on our living standards - which the Bank first flagged last summer - will be deeper than it expected and will stretch well into next year.

The Bank is concerned about wage growth but the irony is that pay rises are being completely outpaced by price rises.

Real post-tax labour income is forecast to fall by an extraordinary 2% this year.

If true, this would prove to be the biggest hit to household spending power since records began in 1990 and a bigger hit than the 1.3% fall experienced in the aftermath of the financial crisis in 2011.

It’s worth noting that the Bank’s forecast does not incorporate the action the government has announced on Thursday morning, which is designed to cushion the impact of a surge in energy bills - which are set to increase by £693 a year from April.

The rebates households receive should leave them with more money to spend than they would have otherwise had but is therefore also slightly inflationary, which in turn implies higher interest rates.

The Treasury’s actions will change the calculation but not the outlook, which for many households is really grim..