Yahoo Finance Interest Rates: Why the Bank of England may have to create a recession
The markets are now expecting the Bank of England (BoE) to raise interest rates to a 15-year high of 4.75% or even 5% on Thursday, with more rises on the horizon after the shock rise in core UK inflation. This has prompted many analysts to question whether a forced recession is on the cards.
Recession needed to tame inflation?
Laura Suter, head of personal finance at AJ Bell, said the BoE is running out of options.
“The only thing they have in their arsenal to try to dampen inflation is raising interest rates harder and faster than they already have. However, they are in a tricky balancing act, where any large leaps in interest rates could push the economy into recession, as people tighten their spending so much that the economy shrinks.”
Last month, the Office for National Statistics revealed that the UK economy grew by 0.2% in April, returning to growth despite high inflation, rising interest rates and disruption caused by strikes.
Gross domestic product (GDP) came in at 0.1% in the three months to April, with the services sector being the main contributor, expanding by 0.3% during the month.
Read more: Bank of England hikes UK interest rates to 5% to combat inflation
Sarah Coles, Yahoo Finance columnist and head of personal finance at Hargreaves Lansdown, also commented on the outcome of a possible recession and said there are signs that higher wages and prices are feeding into one another, and in this environment it may take significant levels of insecurity for businesses and workers to decide they can’t afford to push for more of either.
“A recession may well achieve this, and would be likely to effectively tame inflation, because job insecurity would stifle spending and investment, and suck demand out of the economy. However, it’s unlikely to be the Bank of England’s Plan A. It will hope to tread a fine line between keeping rates low enough to support fragile GDP growth and raising them high enough to keep price rises under control,” Coles told Yahoo Finance.
Meanwhile, Suter also highlighted how the government has more options than the BoE, but said they are all very “unpalatable”.
Read more: FTSE 100 plunges as Bank of England raises interest rate to 5%
“Prime minister Rishi Sunak could opt to raise taxes, cut government spending or cut back on the cost of living payments to try to limit inflation, in a bid to reduce household spending further. But those options put further pressure on the households that are already at breaking point – not to mention the fact that they are politically unpleasant with a general election looming,” she added.
It comes as Phillip Hammond, who served as chancellor from 2016 to 2019, told LBC: “I don’t think The Bank has got much choice [but to tip the country into recession] unless the government does something pretty significant intervening in the labour market in a different way."
Watch: What is a recession and how do we spot one?
Will the BoE need to engineer a recession?
Nicholas Rees, FX market analyst at Monex Europe, said there’s a possibility that the BoE might have to hike to 6% after the worse-than-expected inflation data, which showed the Consumer Price Index (CPI) remained flat at 8.7% in May, higher than the 8.4% economists had expected.
“Bank Rate expectations have been flirting with the idea that the BoE might have to hike to 6% since we saw last week's strong labour market data, and the inflation print [on Wednesday] took expectations a leg higher once again," he said.
“This really speaks to the idea that significantly higher policy rates will have very negative impacts on the real economy with the BoE possibly needing to engineer a recession to break a wage-price spiral, which would weigh on both sterling and gilts, and is seemingly being increasingly factored into market pricing."
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It came as JP Morgan economist Karen Ward, who advises chancellor Jeremy Hunt, also warned that the Bank has to “create a recession” if it is to control inflation.
She said: "They have to create uncertainty and frailty, because it’s only when companies feel nervous about the future that they will think ‘Well, maybe I won’t put through that price rise’, or workers, when they’re a little bit less confident about their job, think ‘Oh, I won’t push my boss for that higher pay’."
However, Dr George Hulene, associate professor in finance at Coventry University told Yahoo Finance he does not think the BoE needs to force a recession to tame inflation.
“I do not think they need to force a recession but they might be forced to do so if they do not get the support from the government to bring inflation down.
Watch: How does inflation affect interest rates?
He added: “If the government is not helping address the supply chain challenges we are experiencing in the country at the moment, in particular around goods, products and services, the Bank of England will have no choice but to keep increasing interest rates over and over until inflation is tamed. This will almost certainly lead to a recession as we are already observing a slowdown in growth."
He comments were echoed by foreign secretary James Cleverly on Thursday, who hit out at suggestions that the UK should intentionally enter a recession to dampen inflation.
Speaking to Sky News he said: “What we need to do is we need to grow the economy. High interest rates don’t help with that. This idea that we should consciously be going into recession I don’t think is one that anyone in government would be comfortable subscribing to at all.”
Watch: UK's Hunt Weighs in on BOE Rate Hikes as Inflation Overshoots
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