Bank of England predicts UK is heading for long recession as inflation peaks above 13%

What will the recession look like and will the government's support packages be enough to see households through the winter? ITV News Business and Economics Editor Joel Hills explains

The Bank of England has called it.

The UK economy is set to fall into a long recession this winter as inflation peaks above 13%, driven higher by a simply mind-boggling surge in energy prices.

The market price of gas has nearly doubled in the past three months, as Russia has restricted supplies to Europe, and is nearly seven times higher than it was last winter.

In May, the Bank assumed the average household energy bill would rise to £2,800 in October, it now believes it will be closer to £3,500.

Only a year ago, the Bank expected the headline rate of inflation to peak at 4%. It now thinks it will reach 13.3% in October, the highest level since September 1980.

The hardship and distress this will cause households and businesses is unimaginable.

The Bank calculates that, even with the package of financial support the government has made available, real post-tax disposable income will fall by 1.5% this year and 2.25% next.

If the Bank is right, it will be first time there has been consecutive annual falls since records began in the 1960s. That’s extraordinary.

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History tells us recessions are hard to spot in advance and central banks tend to be coy about making predictions which may become self-fulfilling.

It is unprecedented for the Bank of England to be stating openly that it can spot another downturn coming.

The Bank believes the UK will enter a technical recession from October, one that will last until the end of next year and see output fall by around 2.1% from peak to trough.

That’s much shallower that the recessions we experienced during either the pandemic or the global financial crisis in 2008/9 and comparable in depth to the one we lived through in 1990/91.

But even when the recession ends, the Bank warns that economic growth is likely to be weak. It’s not clear when GDP is expected to return to it’s pre-recession level.

If these forecast come to pass, the reverberations will be dramatic. Rishi Sunak and Liz Truss will know that governments which preside over big falls in living standards tend to run into big problems.

The economic outlook for growth is dire but the Bank has decided it needs to hike interest rates more aggressively - increasing Bank Rate by 0.5% to 1.75% - the highest rate since 2009 and the biggest single increase since February 1995.

Raising interest rates will intensify the squeeze on the incomes of borrowers and will do almost nothing to alleviate the inflationary pressures caused by either the pandemic (tangled supply chains) or the War in Ukraine (brutally high energy bills).

Raising interest rates will intensify the squeeze on the incomes of borrowers. Credit: PA

Higher inflation inevitably makes us poorer. The Bank has said previously that this pain is unavoidable, all it can do is to try to ensure the pain lasts for as short a time as possible.

The Bank’s worry is that there are signs that inflation is starting to feed itself domestically - that businesses and employees are responding to the cost of living crisis by raising their prices and demanding compensatory wage rises.

The UK labour market is tight. There are a record number of vacancies in the economy and unemployment remains at a near record low. This puts upward pressure on pay. These are just forecasts. As the Bank points out, what happens next is hugely uncertain.

Households and businesses will tighten their belts in the months ahead. It’s possible that the downturn that follows will be so profound that inflation will cool down quickly without the Bank having to do much more tightening.

It’s also possible that the Bank will feel the need to continue raising interest rates aggressively. Either way, the outlook is horrific.

Financial markets are betting that Bank Rate will need to reach 3% by the middle of next year to tame inflation.

The Bank’s forecast suggests that such a path would see inflation back at 0.8% in three years time, well under the 2% target. The Bank seems to take the view that investors have got carried away.

So much now depends on how long the war in Ukraine lasts and what happens to the price of energy. Amid the awful forecasts it’s hard to escape the conclusion the actions of Vladimir Putin are making us much worse off.