Bank of England faces tough choice between inflation and recession

Bank of England

The Bank of England (BoE) is expected to raise interest rates again on Thursday, as it tries to bring down inflation that is running at more than four times its target. However, some analysts warn that the BoE may be risking a recession by tightening monetary policy too much and too fast.

Bank of England

Inflation hits 10.5% in December

The UK inflation rate reached 10.5% in December, the highest level since 1991. The main drivers of inflation were higher energy and food prices, as well as supply chain disruptions and labour shortages that pushed up the costs of goods and services.

The BoE has a legal mandate to keep inflation close to 2%, but it has been above that level since April 2021. The BoE has blamed the inflation surge on temporary factors, such as the Covid-19 pandemic, Russia’s invasion of Ukraine, and Brexit-related trade frictions. However, it has also acknowledged that inflation may persist for longer than expected, and that it needs to act to prevent it from becoming entrenched in people’s expectations and wage demands.

Interest rates rise to 4%

The BoE has already raised its main interest rate from 0.1% in December 2021 to 4% in February 2023, the fastest pace of tightening in its history. It has also reduced its bond-buying programme, which was designed to support the economy during the pandemic, by £100 billion.

The BoE has signalled that it may raise interest rates further, to 4.5% this month, and to 5% by the end of the year. The BoE governor, Andrew Bailey, has said that the BoE is prepared to do “whatever it takes” to bring inflation back to target.

However, some economists and commentators have criticised the BoE for being too hawkish, and for ignoring the negative impact of higher interest rates on the economy and on households.

Recession looms as growth stalls

The UK economy is already showing signs of weakness, as higher inflation erodes consumers’ purchasing power and confidence. The economy contracted by 0.2% in the fourth quarter of 2021, and is expected to shrink again in the first quarter of 2023, entering a technical recession.

The BoE has forecast that the economy will grow by only 0.7% in 2023, down from 6.8% in 2021. It has also warned that there are downside risks to its outlook, such as further Covid-19 variants, geopolitical tensions, and financial market volatility.

Some analysts have argued that the BoE is overestimating the inflation threat, and underestimating the growth threat. They have urged the BoE to pause or reverse its rate hikes, and to adopt a more flexible and gradual approach to monetary policy.

A delicate balance for the BoE

The BoE faces a difficult dilemma: how to balance its inflation-fighting objective with its growth-supporting objective. It has to weigh up the costs and benefits of raising interest rates in a highly uncertain environment.

The BoE has said that it is ready to adjust its policy stance as new information becomes available. It has also stressed that its decisions are not predetermined, and that they depend on the evolution of the economy and inflation.

The BoE will announce its latest monetary policy decision on Thursday at noon GMT. Markets and observers will be watching closely for any clues about the BoE’s future plans and expectations.

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