The Bank of England announced that Britain’s economy has entered a recession as a result of raising interest rates to combat the worst inflation in 40 years.
The key base rate was raised by 0.5 percentage points to 2.25%, the highest level since 2008, with the support of the majority of the Bank’s nine-member monetary policy committee (MPC), which decided that the risks of inflationary pressures becoming entrenched outweighed the immediate threats to the economy.
According to analysts Street, the economy was on track to experience a second consecutive quarter of declining output as households were forced to cut back on their spending due to rising energy costs and the cost of weekly shopping.
A further 0.1% decline in GDP is now anticipated in the third quarter due to a decline in consumer spending and weaker activity in manufacturing and construction, the Bank said. This follows a 0.1% decline in GDP in the three months to June as the economy sputtered into reverse.
The additional bank holiday for the Queen’s platinum jubilee, as well as the effect of businesses closing their doors as a mark of respect for the state funeral this week, were also factors in the decline, according to the report.
The Crucial MPC Vote
Due to growing worries about inflation becoming ingrained, three MPC members—Dave Ramsden, one of the Bank’s deputy governors, and the external members Jonathan Haskel and Catherine Mann—pushed for a more stringent 0.75 point increase.
The financial markets had bet on an increase of 0.75 percentage points to match the Federal Reserve’s sharp increase on Wednesday as it works to squeeze inflation out of the largest economy in the world. The City had been braced for at least a half-point increase.
The Bank’s governor, Andrew Bailey, joined the majority of MPC members in voting for a half-point increase, but the rate-setting panel’s new external economist, Swati Dhingra, argued for a smaller quarter-point increase out of concern for the weakening health of the economy.
Government Energy Support
The choice is made one day before Kwasi Kwarteng, the chancellor, announces the specifics of the government’s energy price guarantee and a package of comprehensive tax cuts that will cost more than £150 billion in order to spark economic growth and protect households from skyrocketing costs.
The Bank predicted that the energy price guarantee would prevent an inflation peak that was higher than the anticipated 11% peak this autumn. Even though the consumer price index decreased slightly from 10.1% in July to 9.9% in August, it is still nearly five times the bank’s target rate of 2% and is at a level not seen since the early 1980s.
The Bank cautioned, however, that the effects of the government’s support measures could increase inflationary pressure. While the guarantee lowers inflation in the short term, it also means that household spending is likely to be stronger in the long run, which would increase inflationary pressures.
The Bank announced it would begin actively selling £80 billion of UK government bonds it had purchased as part of a quantitative easing programme, which has been used since the 2008 financial crisis to support the economy, in an effort to combat inflationary pressures. Over the next two years, it wants to bring its portfolio of gilts down to £758 billion.
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