The UK will enter a prolonged recession this autumn and the economy will continue to contract throughout the year as households are hit by the deepest drop in living standards ever, the Bank of England warned.
In one of the most bleak assessments ever of Britain’s economic outlook, the Bank’s Monetary Policy Committee (MPC) said inflation will now peak at 13.3 percent in the final three months of this year as the average energy bill will triple from £1,200 in 2021 to £3,500 by October.
The inflation forecast was well ahead of the 9.4 percent forecast just two months ago, and prices are now on track to continue rising rapidly into 2023.
It means the cost of living crisis will continue into next year and will not subside until 2024, according to the Bank’s latest forecasts. Real household income is expected to fall by an average of about 5 percent in two years – the deepest decline since the measurements began in 1960.
Experts said energy costs could rise even further in January, with Investec predicting that bills for the average household will now reach £4,210 in January, when regulator Ofgem revises its price cap.
The Bank’s Monetary Policy Committee (MPC) warned that there was “exceptionally high” risk around the latest projections, and that the situation could deteriorate further if gas prices rise further.
Analysts believe this scenario is becoming increasingly likely after Russia cut supplies to Europe last month and governments across the continent began rationing supplies.
The UK economy is now expected to contract for the first time since the 2008 global financial crash in five consecutive quarters.
If the Bank’s latest predictions prove correct, real household incomes will remain below the levels they reached during the crash in 2024, marking an unprecedented period of stagnation punctuated by multiple crises.
The Bank said acute labor shortages will cause companies to continue offering higher wages to recruit skilled workers, but this will be dwarfed by the rising cost of living, driven by energy costs. The average wage increase will be as high as 6 percent — less than half of the inflation peak, the MPC said.
Even after the economy starts to grow, more pain awaits, with unemployment expected to rise from 3.8 percent to 6.3 percent by 2025.
Despite the bleak outlook, the Bank’s nine-member Monetary Policy Committee voted eight to one to raise interest rates by 0.5 percentage point to 1.75% – the highest since January 2009.
The move is hoped to tame uncontrolled price increases, but it also means millions of homeowners will face rising mortgage payments, with average interest rates on track to climb to 3.5 percent.
Overall, the economy is expected to contract by 2.1 percent, meaning the recession will be of a similar magnitude to that of the early 1990s and 1980s, the Bank said.
When the country comes out of recession in 2024, the Bank expects growth to remain close to zero in the coming year.
The massive rise in inflation will also affect public finances, adding billions to the public debt pile and to interest payments on bonds indexed to inflation.
The appalling numbers will worry Liz Truss, who is the favorite to become the next prime minister.
Ms Truss has pledged to cut taxes by billions in an effort to win over members of the Conservative Party. Her opponent in the Tory leadership race, Rishi Sunak, has attacked the plan as fiscally irresponsible.
Neither candidate has detailed plans on how to support families struggling with a rapidly worsening cost of living crisis.
Commenting on the economic forecasts, Labour’s shadow chancellor Rachel Reeves said: “This is yet another proof that Conservatives have lost control of the economy, with skyrocketing inflation set to continue as mortgage and borrowing rates continue to rise.
“While families and retirees worry about how they will pay their bills, Tory leadership candidates are touring the country announcing unworkable policies that will do nothing to help people through this crisis.”
One of the first people to be affected by rising interest rates is the 20 percent of homeowners with variable or tracker mortgages who will see their monthly payments increase immediately.
First-time buyers and people whose current mortgage agreement expires soon also pay more.
Someone who took out a £250,000 mortgage at around 1 percent in 25 years would pay around £942 a month. After today’s rise to 1.7 percent, someone borrowing the same amount, but at 1.7 percent, would pay £1,029 a month.
However, increases in energy prices will have a much greater impact on people’s disposable income. Following the publication of the MPC report, Vice Governor Ben Broadbent said:
Andrew Bailey, the Bank’s governor, said persistent inflation would be “even worse” if interest rates were not raised and lower-income households would be the hardest hit.
Finance Minister Nadhim Zahawi said: “Tackling the cost of living is a top priority and we have taken action to help people through these difficult times with our £37bn household aid package, including direct payments of £1,200 to the most vulnerable families and £400 off energy bills for all.
“We are also taking important steps to bring inflation under control through strong independent monetary policy, responsible tax and spending decisions and reforms to boost our productivity and growth.