ITV News Business and Economics Editor Joel Hills reports on the Bank of England's decision to raise interest rates to 3%
The UK is heading for recession but the Bank of England continues to hike the cost of borrowing in an effort to contain rampant inflation.
The Monetary Policy Committee (MPC) has voted to increase Bank Rate by 0.75% to 3%, the sharpest hike for three decades, and warns that there might be more increases to come.
On the face of it, this seems a little crazy.
Runaway price rises have already left households and businesses feeling poorer.
By increasing interest rates, the Bank is intensifying that squeeze for millions of borrowers.
If the Bank is right a recession has already begun.
The Bank forecasts the UK economy will contract for eight consecutive quarters from October this year.
This would mean two years of uninterrupted negative growth with output falling by 2.9% from peak to trough and unemployment rising to 6.25%.
That’s an horrific prospect but this forecast seems with a health warning.
It is based on an assumption that Bank Rate ends-up reaching 5.25% to get inflation back to target.
In practice, it may never need to get that high.
'These things will be painful and they will also be deeply unpopular with just about everybody'
The Bank of England is hinting heavily that it thinks investors who continue to bet on big interest rate rises to come have got carried away.
It points out that if Bank Rate were to reach 5.25%, it would add £3,000 a year to the cost of servicing the average mortgage.
Many households would struggle to absorb a financial hit of this size.
What happens next is, as ever, immensely uncertain.
Much depends on the war in Ukraine and what decisions the chancellor takes on November 17th.
The Bank calculates that the introduction of the government’s Energy Price Guarantee (EPG) and the decision to reverse the National Insurance increase will cushion the blow to “real” household incomes that inflation and higher interest rates are causing - although they still fall this year (-0.25%) and next (-1.5%).
The EPG is due to be rolled back next April but the Bank assumes that the government will continue to subsidise everyone’s energy bills next Winter, albeit at a less generous rate.
The chancellor is preparing us to expect tax rises and public spending cuts in his Autumn Statement.
These things would intensify the downturn and reduce pressure on the Bank to raise rates.
What’s interesting is the Bank’s forecast suggests that inflation has already peaked - at 11% in October.
Higher interest rates won’t deal with the things that have caused prices to spiral upwards (the pandemic and the war in Ukraine), instead they are designed to prevent inflation taking off domestically.
The Labour market remains tight.
Despite a looming downturn, there are more vacancies than there are people looking for work.
These are the conditions in which inflation could gallop away into the distance.
The evidence suggests that employees and companies have been looking to protect their living standards by asking for higher pay and raising prices.
The brutal truth is that the Bank is moving to crush demand and extinguish the upward pressure on pay.
The result will be higher unemployment but the Bank will argue that’s a price worth paying to tame inflation.
“A stitch in time saves nine”. Not an attractive argument to make, particularly when so many are feeling up against it.
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