Bank of England predicts recession

Inflationary pressures in the United Kingdom and the rest of Europe intensified significantly since the last Monetary Policy Report with wholesale gas prices nearly doubling since May, owing to Russia’s restriction of gas supplies to Europe and the risk of further curbs. As this feeds through to retail energy prices, it will exacerbate the fall in real incomes for UK households and further increase UK consumer inflation in the near term.

Inflation is an important consideration for economies, investors and consumers.

Some inflation can actually be quite welcome. When prices of goods gently increase over time, it encourages consumers to consume today rather than delay purchases until a later date, with only a muted impact to the value of consumers’ savings. This, in turn, encourages companies to produce, and as a result supports the workforce.

However, if there is too little or too much inflation, this can be damaging. Too little inflation, or perhaps even deflation (the opposite of inflation), can encourage consumers to delay purchases if they expect a decrease in the price of goods, which can slow economic growth.

Conversely, too much inflation, and a consumer’s standard of living might drop as goods become too expensive. In both cases, the confidence of consumers and business can be adversely impacted which creates its own feedback loop on economic growth.

Over the last 12 months to June, the rate of Consumer Prices Inflation (CPI) has grown by 9.4%, largely driven by increases for motor fuels and food costs.

Inflationary pressures are expected to dissipate over time although the key issues driving prices to their very high levels, namely the War in Ukraine is out of anyone’s control. Global commodity prices are assumed to rise no further and price inflation is expected to fall back but the timescale for this is increasing, with inflation predicted to be high throughout 2023 now.

The bank has said itself that forecasting at present is fraught with difficulty and a range of outcomes are possible with significant differences between projections in the forecast period. However, all show very high near-term inflation, a fall in economic growth over the next year and a marked decline in inflation thereafter. We were here twelve months ago worrying about deflation so while there are fears that inflation may become entrenched, without being flippant, if some of the external factors were eased, a political solution to the Ukraine War for instance, inflation could fall to lower levels reasonably quickly.

The remit is clear that the inflation target applies at all times, reflecting the importance of price stability in the UK monetary policy framework. The framework recognises that there will be occasions when inflation will depart from the target as a result of shocks and disturbances. The economy has continued to be subject to a succession of very large shocks, which has led to the departure from the 2% target in the short term. Monetary policy will ensure that, as the adjustment to these shocks occurs, consumer inflation will return to the 2% target sustainably in the medium term.

In the Conservative leadership battle, Liz Truss and her allies have repeatedly questioned the performance of the Bank’s governor, Andrew Bailey, and said she would review the Bank of England’s remit if she became Prime Minister.

The business secretary, Kwasi Kwarteng, widely viewed as a potential chancellor under Truss, stated in an interview: “The job of the Bank was to deal with inflation. They’ve got a 2% inflation target, that’s actually their mandate. And now inflation is getting [to] double digits. So clearly, something’s gone wrong. We need to look again at what the mandate is and how best they can actually fulfil that mandate,”

The bank is in a difficult position and has defended its position with the surge in essential goods – energy and food caused by external events and largely out of their control. They will want however to be doing something so the latest rise is to do what they can and prepare for the possible recession where it is a useful tool to have interest rates high enough for them to cut. The comments by the bank may also be veiled support for Rishi Sunak and they have also commented that the policy measures suggested by Liz Truss may lead to interest rates increasing to 7%!

The state pension triple lock is a rule that means the state pension must rise each year in line with the highest of three possible figures, inflation, average earnings or 2.5%.

Last year the average earnings element of the triple lock was suspended as it would mean an increase of 8% on pensions, with the high increase being a result of wage drops due to covid and then a rise, really to put people back in the position they were in before the pandemic.

The Bank’s latest 13%+ inflation forecast for 2022 Q4 threatens another triple lock headache for the Government. The lock is based on the September 2022 CPI figure which is expected to be around 10%. By next April, when the State Pension increase takes effect, a pension uplift based on September 2022 could be well below the spring 2023 inflation rate.