Will the interest rate rise cause a nasty recession?

As Rishi Sunak says he is '100% on it' and that the economy is 'going to be ok', Robert Peston analyses what the PM can actually do to tackle soaring interest rates

In the Bank of England’s mission to reduce inflation back to the target of 2%, the problem it has is recent sharp rises in the interest rate it controls - four percentage points over 15 months - neither worked or hurt.

Unemployment remains near record lows.

Prices of services and wage growth, though both below the headline rate of inflation, indicate that price rises around 7% a year, a multiple of the 2% target, are becoming built into the system, endemic.

So what’s gone wrong? Why is inflation worse in the UK than in other comparable rich countries? Why is the rise in interest rates necessary to defeat inflation seemingly greater here than in the US and eurozone?

There are a number of factors.

One is the tightness of the labour market - the shortage of relevant workers - caused by Covid-19 and Brexit.

Another is the way the mortgage market has changed so much over the past 20 years, with the proliferation of fixed rate deals - such that there is a lag of months and years between a rise in the Bank of England’s interest rate and the impact being felt in householders’ pockets.

It means, as two members of the Bank’s monetary policy committee noted, that we can’t be sure whether it was necessary to raise the rate again today by 0.5%.

That's because it is theoretically possible that inflation will drop sharply, as a million plus people come off fixed rate mortgage deals in the coming year.

It means today’s 0.5% interest rate rise may be a sledgehammer to crack a nut. It may in fact lead to a too-severe fall in house prices and employment.

It could lead to a nasty recession.

We just can’t be certain.

What we do know is that if the politics of immigration wasn’t so toxic, inflation caused by supply shortages would be less of a problem.

And we also know that the Bank of England raised interest rates too little and too slowly over the past two years, because it consistently under-estimated the strength and potential longevity of rising prices.

Which is why, for the first time since the Bank of England was given control of interest rates in 1997 by Gordon Brown, its reputation has been battered - and why questions are being asked about whether that reputation can be rebuilt while the current governor Andrew Bailey remains in post.