“The Bank predicts stagflation and says the medicine is higher interest rates,” said Paul Dales, chief UK economist at Capital Economics.
He calculated that interest rates could have to rise to 3 percent next year and, like many commentators, did not rule out another sharp move of 0.5 percentage points in September or November.
Matthew Ryan, head of market strategy at financial services firm Ebury, said he had “been running out of fingers and toes to keep track of the number of times the MPC has revised the raises its inflation forecasts last year.”
“The priority now remains clearly focused on controlling inflation at the expense of growth,” he said.
The BoE said even the labor market would not escape the economic carnage: the unemployment rate, now at a record low of 3.8%, will rise to 6.3% by 2025.
The big problem for the Bank of England is that no matter how high interest rates are, this will have little impact on the energy bills of households and businesses, which are being driven up by the impact of the war on Ukraine in the global prices of raw materials and energy.
Inflationary pressures have “intensified significantly”, the BOE said in its statement. “The latest rise in gas prices has led to another significant deterioration in the UK business outlook.”
An energy nightmare
The worst of energy inflation is yet to come for the UK. The maximum amount that energy companies can charge households is set at fixed intervals by regulator Ofgem, which in April increased the cap by 54 per cent, for an average annual gas and electricity bill of £1,971 (3440 dollars).
Energy analysis firm Cornwall Insights expects the next review, in October, to increase it to £3358, a 70% increase.
The government has been dishing out money to help cushion the blow: each household gets a payment of £400, and welfare recipients get an extra grant of £650.
On the ledger side of business, Cornwall predicts many businesses could see a fivefold increase in energy costs when their two-year contracts are renegotiated in October.
“While business energy markets have so far managed to cope with price increases… The increase in bills in October, along with other economic concerns seen in the market, could cause businesses to find at the limit,” analysts at Cornwall said in a note.
“This is particularly true for certain businesses whose profitability is more exposed to rising energy costs, such as hospitality, leisure, retail and many in the industrial sector. … Losses of corresponding jobs [could] impact on the whole economy”.
The most recent figure for UK GDP growth was 0.5% in May, after a 0.2% fall in April. The annual rate in the 12 months to May was 3.5 percent.
But retail sales are falling, business confidence has declined and flash PMI economic indicators for both services and manufacturing are slowing.
If the Bank of England continues to raise interest rates as the economy begins to contract, it would be the first time it has had to do so since the stagflationary slump of 1975.
Political pressure
The dismal economic outlook is likely to put further pressure on the government, which has been accused of doing too little to ease cost-of-living pressures and prevent a decline in living standards.
Prime Ministerial hopeful Liz Truss has blamed the BoE for not acting sooner on inflation and promised to review its mandate. But he also proposes massive tax cuts that could further stoke inflation.
Meanwhile, the Bank is also trying to offload holdings of government bonds it bought to keep the economy afloat during the COVID-19 pandemic. It aims to start selling about 10 billion pounds a quarter from September, followed by smaller sales of corporate bonds.