The Bank of England has warned the UK risked being plunged into the longest recession in 100 years after it pushed up the cost of borrowing to 3% in the biggest single interest rate rise since 1989.
A 0.75% increase, the latest in a series of eight interest rate rises since last year, would not be enough to guarantee victory in the war against double-digit inflation, the Bank said, as it cautioned further action would be needed.
The UK economy faces a “very challenging outlook”, with a recession that began this summer now expected to last until the middle of 2024.
With the possibility of a general election being held in 2024, the Conservatives face campaigning to remain in government at the tail end of a prolonged slump, during which the Bank said it expected unemployment to rise from 3.5% to 6.5%.
However, there was some relief for mortgage holders as the central bank downplayed City expectations of a steep rise in the cost of borrowing to above 5%, arguing that the prospect of a two-year recession meant it was likely to take a much less aggressive stance.
Andrew Bailey, the Bank’s governor, said: “We can’t make promises about future interest rates, but based on where we stand today, we think the bank rate will have to go up by less than currently priced in financial markets.”
Bailey and his officials expect inflation to fall to zero by 2025, and analysts at Berenberg Bank are forecasting only one more rate rise, to 3.5%.
Bailey said higher borrowing costs were already affecting households.
“These are big changes and have a real impact on people’s lives,” he said at a press conference after the publication of the Bank’s quarterly monetary policy report.
Homebuyers with tracker or variable rate mortgages will feel the pain of the rate rise immediately, while the estimated 300,000 people who must remortgage this month will find that two-year and five-year fixed rates remain at levels not seen since the 2008 financial crisis.
The Bank said the cost of fixed-rate mortgages had already come down from the levels seen at the height of the panic in the wake of Kwasi Kwarteng’s badly received mini-budget, which sent them soaring above 6%.
Hinting at the Bank’s concern about the fragility of the housing market, Bailey said he hoped home loan providers would react by continuing to cut the cost of their products to homebuyers.
Bailey said he recognised the pain caused by tougher interest rate policy, but added: “If we do not act forcefully now it will be worse later on.”
The Bank now expects inflation, which hit 10.1% in September, to peak at 11% by the end of 2022, and then to fall “probably quite sharply” from the middle of 2023.
It blamed higher energy prices and a tight labour market for the big increase, which matched aggressive rises in the last week by the US Federal Reserve and the European Central Bank.
The last time UK rates rose by more than 0.5% was in 1989. John Major’s government was forced into a 2% rise during the exchange rate mechanism crisis in 1992, though for less than 24 hours before it was scrapped.
The vote to raise rates was split 7-2 among the nine members of the monetary policy committee (MPC) after Silvana Tenreyro voted for a 0.25% increase and Swati Dhingra voted for a 0.5% jump. Both are professors at the London School of Economics. They argued the full effects of eight consecutive rises should be allowed to feed through into the wider economy before more severe action was taken.
The chancellor, Jeremy Hunt, said: “Inflation is the enemy and is weighing heavily on families, pensioners and businesses across the country. That is why this government’s No 1 priority is to grip inflation, and today the Bank has taken action in line with their objective to return inflation to target.”
Rachel Reeves, the shadow chancellor, said: “Families now face higher mortgages and more anxiety after months of economic chaos.
“Working people are paying the price for Tory failure. Britain deserves more than this.”
On alternative assumptions that rates remained unchanged at 3%, the economy would still continue contracting until the end of 2023 but the cumulative fall in output would be 1.7% rather than 2.9%, and unemployment would peak at just over 5%.
The Bank said it had not factored in any action by Hunt in his autumn statement on 17 November, though the chancellor is expected to announce a package of tax increases and spending cuts worth up to £50bn.
Kallum Pickering, a UK analyst at Berenberg, said: “While a lot will depend on the upcoming [budget] announcement, today’s policy decision and guidance support our call that the Bank will hike the bank rate just once more by 0.5 points in December to a peak of 3.5%.
“Thereafter, we expect the Bank to remain on hold in the first half of 2023 before cutting the bank rate modestly, by about 0.5 points, in the second half of 2023.”
The risks to this call are tilted slightly towards one further 0.25 point hike in February.”