The Bank of England is confronting some stark and uncomfortable facts. Not since 1977 have British households faced food prices rising at a faster pace, while the headline rate of inflation is stuck above 10% – higher than in any other G7 nation.
It is against this backdrop that City economists reckon the central bank will raise interest rates for a 12th consecutive time on Thursday, with predictions for a quarter-point rise from the current level of 4.25%.
However, despite inflation standing at more than five times the Bank’s target, attention is turning to whether this could be Threadneedle Street’s final rise of 2023 – as households and businesses feel the pinch from the most aggressive rise in borrowing costs since the 1980s.
On the Bank’s monetary policy committee, some officials are becoming uncomfortable over the pace of rate increases from the record low of 0.1% in December 2021. Many households are yet to see the full impact, given that most mortgage holders fix their borrowing costs for at least two years. However, more people are rolling off cheap deals struck in the past, into the new, high-rate world.
An estimated 1.7m mortgages will hit the end of their fixed term this year, landing borrowers with a dramatic rise in their monthly payments.
Amid fears over the fallout from the worst banking crisis since 2008 in the US, and with the cost of living crisis squeezing British households, these are all strong potential headwinds for the UK economy – so strong they could even tame inflation without the need for significantly higher rates.
In the US, investors are betting the Federal Reserve has reached the apex of its rate-increase cycle, after a quarter-point rise last week to between 5% and 5.25% – the highest level for 16 years. The European Central Bank is also thought to be close to its peak, after increasing the deposit rate by a quarter-point to 3.25% last week.
The Bank of England is widely expected to follow suit. UK inflation remained stubbornly high at 10.1% in March – almost a full percentage point higher than the Bank’s forecasts, and almost twice the rate in the US – as soaring food prices kept up the pressure on struggling families.
Alongside the delayed impact of soaring energy costs for food production, now feeding through to the supermarket shelves, some observers warn that companies are profiteering – adding a “greedflation” layer to the cost of living crisis.
Despite this, economists predict headline inflation will fall rapidly when figures for April are published later this month. The big reason is the anniversary of April 2022’s 54% increase in the Ofgem energy price cap, which will drop from the annual calculation for the inflation reading. In addition, global energy prices have fallen in recent months back to the levels seen before Russia’s invasion of Ukraine, while commodities vital for the production of food have also dipped in price.
However, there are signs that Britain’s economy is performing much more strongly than expected. Late last year, the fear was that the worst hit to living standards since the 1950s would force a sharp retrenchment by consumers. Business confidence was wafer-thin, while the disastrous Liz Truss premiership made matters worse. Fast forward six months and economic growth is far from stellar. But a damaging recession also looks to have been avoided.
Economists at Goldman Sachs reckon falls in wholesale energy and food prices will bring down inflation, but that a far more resilient growth performance could ensure the reading sticks firmly above the Bank’s 2% target. As a result, Threadneedle Street’s final rate increase could still be some months into the future.
For households and businesses already struggling with high borrowing costs, that spells more discomfort to come.
