UK in ‘prolonged recession’ as Bank of England hikes interest rates to 3%, knocking pound – as it happened

Time to recap, after a busy day in which the UK central bank unleashed its most forceful act to tame inflation for 30 years.

Homeowners are facing the biggest single shock on their mortgage bills since the 1980s as the Bank of England hiked interest rates for the eighth time in a row.

But the UK’s central bank has also tried to calm fears that interest rates could hit 5%, warning that this would trigger a very painful two-year recession.

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The Bank’s base rate has been lifted to 3% from 2.25%, its highest for 14 years, which will add around £3,000 per year on to mortgage bills for those households that are set to renew their mortgages, on average.

More than two million people on variable rate mortgages will suffer an immediate hit, while approximately 1.8 million households whose mortgages are up for renewal next year face a jump in their repayments too.

Bank governor Andrew Bailey defended hitting households with higher borrowing costs. He warned that inflation was too high, and would cause more pain if it wasn’t brought down.

He told reporters:

“If we do not act forcefully now it will be worse later on.”

And the Bank also pushed back against recent market expectations that interest rates could hit 5.25% next year.

Bailey explained:

“We can’t make promises about future interest rates but based on where we stand today, we think Bank Rate will have to go up by less than currently priced in financial markets.”

Its latest economic forecasts showed that hiking that high would push the UK into the longest downturn in modern history – a two-year contraction.

But if rates stayed at 3% the recession would last five quarters – which will still be a heavy blow to many households and firms.

In both scenarios, UK inflation falls back from its current double-digit levels and undershoots its target towards the end of the forecast period – a sign that the Bank doesn’t anticipate hiking rates as high as 5%.

Two of the Bank’s nine rate-setting policymakers, Silvana Tenreyro and Swati Dhingra voted against the hike, favouring smaller increases in borrowing costs, given the UK’s economic plight.

Tenreyro, who only wanted a 25-basis point rise, pointed out that monetary policy had already been restrictive in light of falling real incomes, with the economy now likely to be entering recession.

In a gloomy warning, governor Bailey said the turmoil hitting the UK is worse in economic terms than what hit in the 1970s, due to the Ukraine war and supply chain disruption following the pandemic.

“This is a huge shock.”

“If you compare this to the 1970s, and you compare this year to single years in the 1970s, and also government policies comes into play there in terms of energy markets. This is a bigger shock than in any year in the 1970s.”

And Bailey signalled that mortgage rates should come down, as the markets adjusted:

We can make no promises about future interest rates.

But based on where we stand today, we think [rates] will have to go up by less than currently priced into financial markets. That is important because, for instance, it means that the rates on new fixed-term mortgages should not need to rise as they have done.”

The Bank also showed how political upheaval had pushed up UK borrowing costs:

The pound fell sharply as traders digested Bailey’s words. Sterling has shed over two cents against the dollar to $1.118, with one investment manager warning the pound is trapped in a ‘currency doom loop’.

Chancellor Jeremy Hunt admitted that the rise would be very tough for families with mortgages and businesses with loans, and warned of ‘difficult decisions’ ahead:

“The most important thing the British Government can do right now is to restore stability, sort out our public finances, and get debt falling so that interest rate rises are kept as low as possible.

“However, there are no easy options and we will need to take difficult decisions on tax and spending to get there.”

His Labour counterpart, Rachel Reeves, said PM Rishi Sunak should face up to the mistakes that have left the UK in a “vicious cycle of stagnation”.

“Families now face higher mortgages and more anxiety after months of economic chaos.

“Today’s recession warning lays bare how 12 years of Tory government has weakened the foundations of our economy, and left us exposed to shocks, lurching from crisis to crisis with falling living standards and low growth.

The Resolution Foundation said over five million households are set to see their monthly mortgage bills increase sharply over the next two years, by an average of around £3,900.

Citizens Advice urging banks to show understanding to anyone struggling with loan repayments, and to reach out in case customers need help, but are too worried to ask.

Morgan Wild, head of policy at Citizens Advice, says:

“Right now, people are facing a double whammy of soaring interest rates and sky-high inflation.

Economists warned that lifting interest rates so sharply, in an effort to lower inflation, are worsening the near-term economic outlook.

Melanie Baker, senior economist at Royal London Asset Management, explained:

“Despite another set of grim forecasts for the real economy, including for the unemployment rate, they hiked 75bp today. It is clear that their focus remains inflation.

Here’s our latest news story on the Bank’s decision:

Analysis from our economics editor Larry Elliott:

And an explanation about how higher rates will affect you:

Dr Alla Koblyakova, an expert in mortgage finance at Nottingham Trent University, flags that higher interest rises will hit millions of mortgage holders hard:

“Around 80 per cent of UK mortgage borrowers are on variable, tracker or short-term fixed rate mortgages of only three years. This equates to more than eight million households in the UK. Many of those fixed-term mortgages will be ending soon. That is a huge amount of people who will soon be exposed to much higher interest rates, and the impact on house prices is going to be extremely negative in the short run.

“For a £150,000 mortgage, based on today’s announcement, the average household will need to spend about £250 more per month on their monthly mortgage payments.

“The impact will be asymmetric and more profound in London, the south east and south west, due to those areas having the highest property prices and mortgages in the country.

Dr Koblyakova adds that the government should consider intervening to cap the amount of profit that lenders can make on top of the base rate to help protect borrowers.

Here’s a video clip of Andrew Bailey’s press conference:

2:01

The pound is on track for its worst day against the US dollar since the day of the mini-budget.

Sterling is still down over 2 cents against the greenback tonight, after the Bank of England warned the UK faces a protracted recession, and hinted rates will peak lower than expected.

Charles Hepworth, investment director at GAM Investments, says there is a big contrast between the BoE and the Federal Reserve – which warned last night that markets were underpricing future US interest rate hikes.

This is entirely down to the fact that the UK economy is in a much weaker position than the US and the Bank believes we are already in a recession which will see GDP fall for a record-breaking eight quarters into the middle of 2024.

“With a less aggressive central bank, the release valve in sterling is where the market action is and it is trading a lot lower against the dollar (down close to 2% on the day).

The Bank is stuck in a hole: currency weakness pushes up imported inflation, but hiking aggressively into the teeth of a recession is never normal policy, yet they are. It’s difficult to see how this currency doom loop can be escaped.”

The Bank’s monetary policy report has also shown the damage caused by the mini-budget

This chart shows how ‘UK factors’ pushed up the cost of government borrowing (measured by the yield on British gilts).

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The Bank says that part of the repricing in these rates since August reflects global developments, but there had clearly been an important UK-specific component too.

One model estimated by Bank staff that decomposes movements in 10-year gilt yields suggests that UK factors have played an increasingly significant role in driving yields since August

According to market contacts, these UK factors included a higher central expectation for Bank Rate, heightened political and economic uncertainty associated with the Government’s fiscal announcements, and market illiquidity.

Money market expectations for UK interest rates next year have actually risen a little today, from 4.6% to 4.7%:

Capital Economics aren’t convinced that market expectations for UK interest rate rises are too high.

Their UK economist Ruth Gregory thinks rates will hit 5% next year, despite the Bank of England’s dovish noises today.

She explains:

Although the Monetary Policy Committee raised interest rates today by 75 basis points, from 2.25% to a 14-year high of 3.00%, it sent the strongest signal yet that it thinks rates won’t need to rise much above 4.00%.

But with price/wage expectations still elevated, we think the inflation battle is far from won and that rates will peak at 5.00% rather than the 4.25% expected by most economists.

Downing Street said there will be “difficult choices” to come on tax and spending after the Bank of England hiked interest rates for the eighth time in a row today.

Responding to the Bank of England’s move, a No 10 spokeswoman said:

“The Prime Minister recognises that this will be a worrying and difficult time for people, families and businesses across the UK.

“The number one priority for his Government is bringing down inflation. There will be some difficult choices, but we will ensure that we are actually fairly, protecting the most vulnerable and continuing to seek long term growth.”

Pressed on whether Rishi Sunak agrees with the Bank that there is going to be a long recession, she said:

“We recognise that people will be concerned by those forecasts.

Again, that’s why, as the Chancellor said, the best thing the Government can do if we want to bring down rises in interest rates is to show that we’re bringing down our debt.

He was clear there are no easy options, we (will) need to take difficult decisions on tax and spending to get there, but economic stability is the priority for this Government.”

Our Politics Live blog has all the latest from Westminster:

Bloomberg are reporting that Chancellor of the Exchequer Jeremy Hunt has likened his job to the “interesting shit” that faced Barack Obama during the 2008 financial crisis.

They say:

Hunt told a gathering of senior business people on Tuesday that the UK is in a “very challenging situation.”

Describing the economy he inherited, Hunt repeated a quip Obama made 14 years ago, saying: “This would be really interesting shit if I wasn’t in the middle of it,” according to a person present.

The chancellor drew laughs after citing Obama’s famous comment from his presidential campaign during the finanancial crisis, Bloomberg adds, but “some attendees took a dim view”.

One obvious difference is that Obama picked up a crisis created on Republican George W Bush’s watch, while Hunt is clearing up his own party’s mess.

Here’s the full story: Chancellor Jokes About Britain’s Dismal Economic Situation

Update: A reader kindly reminds me that Hunt has used this analogy before:

Governor Andrew Bailey has recorded a video clip, explaining that the Bank raised interest rates by three-quarters of a percentage point because inflation is too high.

He says he knows that high interest rates will have a real impact on people, at a time when many people are struggling with high energy and food costs, and other bills.

But ‘low and stable inflation’ is vital for a healthy economy, he adds, letting people plan with confidence.

And he adds that inflation is expected to fall quite sharply from the middle of next year: