The Bank of England has today announced a 0.5% increase in base rates which now stand at 1.75%. This is the most significant rate increase for 27 years and places the UK on the precipice of a recession as the fight to control inflation continues. While there will be far-reaching consequences for many in the UK, an extended period of ultra-high inflation would cause even more problems. Portrayed as short-term pain for long-term gain, many businesses and consumers will not see it that way!
Inflation is now front and centre
Ironically, in the second half of 2021, the Bank of England was reluctant to increase base rates to avoid the growing threat of inflation. While this position changed somewhat towards the end of the year, it was only in early 2022 that inflation seemed to take centre stage. Struggling to catch up with central-bank counterparts around the world, who reacted much quicker than the Bank of England, UK inflation is forecast to remain one of the highest in the developed world.
Housing market under pressure
Property website Rightmove calculates that the average monthly mortgage payment will account for 40% of gross household income after today’s interest rate rise. These are levels not seen since 2012, with a first-time buyer mortgage on the average UK property now set to top £1,000 a month. There are also concerns regarding the 10% minimum deposit required for many properties, which currently equates to £22,494. This is a 57% increase on the figure just a decade ago which came in at £14,316, and that’s before any buyer’s premium!
Business expansion plans under pressure
Like consumers, many businesses have grown used to the historically low interest rates of recent years. Previously used in a relatively responsible manner to expand operations, many companies have already confirmed they will be reining in their expansion plans. There is also the knock-on effect to trade customers and consumers who are likely to reduce their spending. In what could quickly become a vicious circle, the short-term prospects for the UK economy are challenging to say the least.
Energy costs play a significant role
Andrew Bailey, the governor of the Bank of England, highlighted the Russian war in Ukraine and the impact on energy prices. Seen as a significant short-term threat to even higher inflation, there is little the Bank of England can do to offset this challenging scenario. However, behind the scenes, food inflation is said to be running at double digits, so work needs to be done before the eventual reduction in energy prices.
While UK economic performance has been stronger than many had expected over the last few months, Bailey confirmed that Bank of England forecasts were “exceptionally large”. There are so many unknown factors that it is difficult to make any confident prediction about how the UK economy will perform in the short to medium term. However, many analysts believe there will be a recession. The impact of high inflation will take some time to filter through the system, with businesses and consumers feeling the pinch.
More interest rate rises are on the way!
In a fairly blunt warning to the money markets, the Bank of England confirmed that all options are on the table concerning the September MPC meeting. Seen as a suggestion we could see a similar increase in base rates; markets are starting to fear the worst. The fact that a majority of 8 – 1 voted for the 0.5% increase suggests there is still more extreme pain to come in the short term. If only the Bank of England had begun the attack on inflation towards the end of 2021!