Bank of England faces dilemma inflation fight vs recession risk

Bank of England faces dilemma inflation fight vs recession risk

Bank of England Faces Dilemma as it Considers Another Interest Rate Hike

London, Aug 2 (ANBLE) – As the Bank of England (BoE) prepares to announce its latest decision on interest rates, it finds itself in a delicate balancing act. On one hand, it needs to combat inflation that is running more than four times its target. On the other hand, it must consider the potential negative impact on the economy from the 13 consecutive rate hikes it has implemented thus far.

Analysts and investors widely anticipate a quarter-point increase, which would bring the Bank Rate to a 15-year high of 5.25%. Stakeholders will also be closely watching for signals from Governor Andrew Bailey and other top officials about future rate increases.

The BoE acknowledges that the full economic impact of its previous rate hikes, which began in late 2021, has not yet been felt. Simultaneously, they recognize the urgent need to rein in inflation, which currently ranks the highest among major global economies.

Inflation Threat

In June, British consumer price inflation unexpectedly declined to 7.9% in annual terms, dropping significantly from May’s 8.7%. While this may appear positive, it remains the highest among the Group of Seven nations. Core inflation, which excludes volatile energy, food, alcohol, and tobacco prices, also eased slightly but still lingers close to the 31-year highs reached in May.

Inflation Chart

Housing Market

The most noticeable impact of the BoE’s rate hikes, which began in December 2021 and have incrementally raised rates to the current 5.0%, can be observed in the housing market. House prices, as measured by mortgage lenders Nationwide and Halifax, have experienced the steepest annual decline in over a decade. Rising interest rates on mortgages have led to expectations of further borrowing cost increases, fueling this downturn.

Nonetheless, the BoE notes that the housing market’s response to its rate hikes has not fully materialized. The majority of mortgages in Britain are short-term fixed-rate deals, shielding homeowners from sudden shifts in borrowing costs. However, as these deals expire, renewals at higher rates could lead to a more substantial impact. Approximately 800,000 fixed-rate mortgages out of nearly 7 million are set to end in the second half of 2023, with an additional 1.6 million expiring in 2024.

Housing Market Chart

Insolvencies

Rising borrowing costs, a sluggish economy, and reduced government support following the COVID-19 pandemic have left many companies, particularly smaller ones, struggling to stay afloat. The second quarter of 2023 saw the highest number of company insolvencies in England and Wales since 2009.

Insolvencies Chart

Labour Market

Although many companies continue to hire and are offering substantial wage increases to attract and retain staff, the situation raises concerns for the BoE’s battle against inflation. Data for the three months leading up to May revealed that wages, excluding bonuses, witnessed the joint highest increase since records began in 2001.

However, there are indications of a cooling labor market. The unemployment rate unexpectedly rose to 4% between March and May, and the number of job vacancies declined for the 12th consecutive month, reaching its lowest level since mid-2021.

Unemployment Chart

Consumers Continue Spending

Despite the squeeze of inflation on incomes, most consumers have managed to sustain their spending habits. Retail sales volumes surprisingly rose in June compared to May, although they remained 1.0% lower than the previous year.

Many individuals still maintain savings from the pandemic. The saving ratio, a measure of households’ saved income, including employer pension contributions, as a percentage of disposable income, stood at 8.7% in early 2023. Although lower than the 9.3% in late 2022, it remains higher than the pre-pandemic level of 5.6%. Consumer confidence, as surveyed by polling firm GfK, fell in July after reaching a 17-month high in June. Despite this decline, it remains below levels seen in most of the past decade. Additionally, household indebtedness remains below pre-2007-2009 global financial crisis levels.

Savings Chart

Recession Risk Remains

Although the economy has defied recession forecasts made a few months ago, the recent surge in expectations for higher borrowing costs poses a risk of contraction this year. According to data up until the end of the first quarter of 2023, British gross domestic product has recovered more slowly from the pandemic compared to all other G7 economies except Germany.

GDP Chart

As the Bank of England weighs the impact of its rate hikes, it faces the challenge of effectively managing inflation whilst avoiding undue harm to the economy. The decision on interest rates will certainly be influential, shaping the economic trajectory for the United Kingdom in the coming months.