The Bank of England (BoE) has warned that the UK could plunge into recession later this year amid soaring energy prices and living costs.
The central bank on Thursday said the economy is set to contract sharply in the last quarter of the year when the energy price cap is lifted again, following a sharp downgrade by its analysts.
Output has been predicted to collapse by close to 1% in the final three months of 2022.
Bank analysts had also previously forecast for growth of 1.25% in 2023, but are now warning that GDP is expected to shrink by 0.25% next year. This would mark the second annual contraction in just four years.
“Global inflationary pressures have intensified sharply following Russia’s invasion of Ukraine. This has led to a material deterioration in the outlook for world and UK growth,” it said.
“These developments have exacerbated greatly the combination of adverse supply shocks that the United Kingdom and other countries continue to face. Concerns about further supply chain disruption have also risen, both due to Russia’s invasion of Ukraine and to COVID-19 developments in China.”
What is a recession?
Usually, when a country’s output is growing, the value of the goods and services it produces, known as its gross domestic product (GDP), goes up. But during an economic downturn this value falls.
A recession is a period of negative economic growth for two consecutive quarters. It is when GDP drops for two three-month periods in a row, and comes as a sign that the economy is weakening.
Although the Monetary Policy Committee (MPC) said the UK will avoid a technical recession (two quarters of negative quarter on quarter GDP growth), output will collapse by close to 1% in the final quarter of 2022 as the cost-of-living crisis bites.
Watch: Will interest rates stay low forever?
It comes as the BoE raised UK interest rates to 1%, the highest level in 13 years, in an attempt to keep a lid on runaway inflation in the medium term.
Despite worrying signs that the British economy is slowing, members of the MPC voted 6-3 on Thursday to increase the benchmark cost of borrowing for the fourth consecutive time.
Rates are now at their highest level since February 2009, when they were hiked during the recession that was caused by the 2008 financial crisis. This sent the pound to its lowest in almost two years, since June 2020, and triggered a drop in government bond yields.
The move has been made to cool down the demand for labour and place upward pressure on pay.
Caspar Rock, chief investment officer at Cazenove Capital, said that there was little surprise about the Bank's decision on Thursday.
“The Bank is having to walk a tightrope when it comes to tackling the current inflation surge such that it doesn’t induce a recession, but the 0.25bps hike is a necessary step in our view.
“Whilst we do not expect to see a repeat of the inflation we saw in the 1970s, we could once again be facing a period of stagflation – that is low growth in combination with higher inflation.”
Inflation hit a fresh 30-year high of 7% in the year to March on the back of soaring energy, fuel and food prices, well above the Bank’s 2% target.
It is now expected to reach as high as 10% later this year, accelerated by April’s energy price cap jump of 54%, and the ongoing war in Ukraine. This will be its highest level since 1982.
Other updates from the BoE on Thursday included forecasts that pay growth will hit 5.75% in 2022, much higher than February's prediction, before falling again in the following two years.
Meanwhile, unemployment will drop this year before climbing to 5.5% by 2025, meaning around another 450,000 people would be out of work. This also adds pressure to the economy.
Households are also facing a 1.75% decline in real disposable income this year, the second biggest fall since 1964.
“It is hard to envisage the government watching the economy slide into recession without doing something to alleviate the pain. The Bank has upped the pressure on Rishi Sunak to act – and act big.