Bank of England hikes interest rates to 1% amid cost of living crisis

Bank of England hikes interest rates to 1% amid cost of living crisis

The Bank of England (BoE) has raised interest rates from 0.75% to 1%, in an attempt to fight rising inflation.

The bank’s Monetary Policy Committee (MPC) by a majority of 6-3 to increase the bank rate by 0.25 percentage points. Those members in the minority preferred to increase the rate by 0.5 percentage points, to 1.25.

Living costs are rising steeply, in March prices had risen by 7% compared to a year ago. The bank pointed to higher prices for goods and rising energy prices as major contributors to the cost of living crisis. The bank also highlighted that Russia’s invasion of Ukraine has led to more increases in the prices of energy and food. Announcing the latest increase, the BoE warned that it expects inflation to rise to around 10% this year, while the economy is projected to slump further.

Nevertheless, the BoE expects inflation to fall back next year and be close to its target of 2% in around two years. It added that it may need to increase rates further in the coming months, but stressed that this depends on what happens in the economy.

Peter Gallanagh, CEO for Scotland and the North at Azets, the UK’s largest regional advisor to SMEs, said that the SME community will be disproportionately impacted by the increase in interest rates.

He said: “This is the first time in 13 years that the UK base rate has been at 1%. The interest rate rise, whilst still historically low, will place additional repayment burdens on borrowers and in turn impact on SMEs as spending starts to be curtailed. With more than 300,000 SMEs in Scotland any further interest rate rises will have a significant effect on the economy, employment and tax receipts.

“Inflation, currently at 7%, is at a 30-year high due to an unprecedented confluence of factors. These include the pandemic, global supply chain disruption, Brexit, a lack of skilled workers and materials to meet demand, tax rises, the record number of job vacancies at nearly 1.3m, the energy price cap increasing by nearly £700 for 18 million householders and the worrying international situation”.

“The Bank of England is using the rate rise as a tool to tackle inflation and Peter Gallanagh warns that soaring inflation will compound the problem: “Inflation is set to increase well beyond the current rate of 7% with further interest rate rises highly likely. Additional rate rises will trigger a further tightening of consumer spending and reduced footfall both in person and online.”

Peter Gallanagh urged SME business owners concerned about the multiple financial pressures to seek advice sooner rather than later as early intervention can significantly reduce the risk of trading and cash flow problems.

Paul Clifford, regional CEO at Azets, added: “This is the first time in 13 years that the UK base rate has been at 1% – many businesses and the 1m-plus householders on variable mortgage rates aren’t used to seeing a continuous rise in borrowing costs and the impact that has on budgets.

“This is also the fourth rise in half a year, from 0.25% in December. The interest rate rise, whilst still historically low, will now place additional repayment burdens on borrowers and have a knock-on impact on businesses as spending is reined in, with SMEs likely to be hit hardest.

“Inflation, currently at 7%, is at a 30-year high due to an unprecedented confluence of factors. These include the pandemic, global supply chain disruption, Brexit, a lack of skilled workers and materials to meet demand, tax rises, the record number of job vacancies at nearly 1.3m, the energy price cap increasing by nearly £700 for 18 million householders and the worrying international situation with adversarial Russia.

“The Bank of England is using the rate rise as a tool to tackle inflation but in doing so may trigger a further tightening of already hard-pressed discretionary spending from consumers facing demands on their incomes.”

He continued: “It is worth recalling that it was in February 2009 when we were last at a 1% interest rate, when the UK was in recession due to the global financial crash, with several high street banks being bailed out by the taxpayer due to a liquidity crisis and unemployment was at 2m, with inflation at around 3%.

“What we are seeing now are a completely different set of economic circumstances, far beyond what any of us could have imagined 13 years ago.”

He concluded: “However, many businesses are resilient and have benefited from significant efficiencies made during the pandemic, meaning they are better placed to absorb inflationary pressures. This is borne out by Azets’ latest SME Barometer, which indicated that more than half of companies expect turnover to increase over the year despite economic challenges.”

Martin Beck, chief economic advisor to the EY ITEM Club, commented: “Another MPC meeting, another rise in interest rates. The 25bps increase announced today took Bank Rate to 1%, a level not exceeded since 2009. The MPC’s vote was split, with three members voting for a bigger, 50bps, rise.

“Policy was tightened despite a significantly downgraded growth forecast. GDP is now expected to fall by nearly 1% in Q4 2022 and calendar-year growth is forecast at -0.25% in 2023, down from the +1.25% predicted in February. While the MPC is not expecting a technical recession (two successive quarters of negative growth), it does see the economy contracting in two of the four quarters from Q4 2022 to Q4 2023. Moreover, with inflation surprising to the upside in recent months, the MPC expects the CPI measure to now peak at 10% later this year.

“The EY ITEM Club thinks the economy is unlikely to perform as poorly as the MPC expects. For one, the committee’s projections are conditioned on market expectations for interest rates which look too aggressive. Investors expect Bank Rate to reach 2.5% by Q2 2023, a level which would mean inflation, in the MPC’s view, significantly undershooting the 2% inflation target over the medium term and a significant amount of spare capacity opening up. Meanwhile, the recent fall in wholesale gas prices (which are currently closest to the lowest since last summer) and the likelihood of more government support to households in this Autumn’s Budget point to a smaller rise in energy bills later this year than expected, keeping inflation from reaching the double-digit rate expected by the MPC. And the strength of household and corporate balance sheets, with households and non-financial companies sitting on over £300bn of ‘excess’ savings accumulated during the pandemic, may offer greater scope to mitigate cost of living pressures than the MPC is allowing for.”

He added: “May’s policy statement said that “most” members felt more tightening would be needed in the coming months. But the committee’s gloomy expectations for GDP growth and cost of living pressures already facing households suggest it will take a cautious approach to future tightening. And the possibility that the near-term inflation outlook may prove to be less bad than expected could also rein back the committee’s hawks. The EY ITEM Club expects only one further rate rise this year. With sterling weakening immediately following the MPC’s announcement, markets appear to be shifting towards our more dovish view.

“Meanwhile, the MPC had said last summer that Bank Rate reaching 1% would be the threshold at which it would consider selling some of the £875bn of gilts purchased under the QE programme. With that threshold now met, the MPC said that Bank staff would work on a strategy for gilt sales, with an update to come in August. With financial conditions having tightened significantly in recent weeks (for example, the 10-year gilt yield recently exceeded 2% for the first time since 2015), and the step into the unknown “active” quantitative tightening would represent, this seems a sensible approach given the headwinds the economy already faces.”

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