The Bank of England's gloomy forecast for inflation and the UK economy

Andrew Bailey — Inflation was rising in the UK even before Russia's invasion of Ukraine.

(Image credit: ©Getty)

The Bank of England has set off “the most piercing of warning sirens”, says Faisal Islam on the BBC. Last week the Bank’s Monetary Policy Committee (MPC) raised interest rates by half a percentage point to 1.75%, “the largest interest-rate rise in a quarter of a century”, while forecasting that inflation will peak at 13% later this year.

Even more shocking, it is now predicting that the UK is heading for “a recession as long as the great financial crisis and as deep as that seen in the early 1990s”.

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Inflation-adjusted post-tax household incomes are projected to shrink by an unprecedented 5% over the next two years.

“I cannot remember a central bank... being this negative about its own economy,” says John Authers on Bloomberg. Central bankers usually tiptoe around uncomfortable truths, so the bank’s “brutal honesty” is a breath of fresh air.

These forecasts mark the end of any talk of striking a careful balance between supporting growth and fighting inflation. Clearly, the MPC has decided that “it has no option but to engineer a more severe economic downturn in order to bring inflation down”.

A day late and a pound short

The Bank has embarrassingly failed to achieve its only job – to keep inflation at 2%, says Alistair Osborne in The Times. “In what other job can you miss your only target by a factor of six and still take home [governor Andrew] Bailey’s £575,338-a-year pay?” Interest rates of 1.75% look like a “peashooter” in the face of this inflationary monster.

While the Bank is keen to blame everything on Russia’s invasion of Ukraine, inflationary pressures have been “bubbling up for ages: the result of a decade of easy money” and “central-bank groupthink”. It was “too slow”, adds a Times editorial, to respond to the risk that soaring commodity prices would “trigger a wage-price spiral”. Now it acknowledges that “the greatest risk... lies in the tightness of the labour market”.

Still, history hardly suggests that removing its independence or “allowing politicians greater sway over how much and when interests rise” would be preferable, says Robert Peston in The Spectator. The independence of the Bank of England, granted in 1997, has helped the UK to command the confidence of bond markets. Politicians’ influence over interest rates helps explain why in the 1980s the UK paid between 9% and 13% to borrow for ten years, compared with 6%-8% paid by West Germany, where the Bundesbank was already independent.

As former MPC member Kate Barker tells Oliver Shah in The Times: “If you look back at the benefits that were originally delivered in 1997, and you saw the increased confidence in the bond market that came from Bank independence… with the level of borrowing that we have recently done, and maybe intend to do, it would seem a very funny time to give that up.”

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.