- Higher than expected inflation could mean further rate hikes ahead
- Economists think BoE must drive down demand to bring inflation back to target
Disappointing inflation figures could see the Bank of England (BoE) increase interest rates enough to trigger a UK recession, economists have warned.
Analysts at Capital Economics said that high core inflation could see the BoE hike rates from 4.5 per cent to a peak of 5.25 per cent later in the summer, making a recession at some point more likely. However, they suggest the "recent resilience" of the economy meant it would happen "a bit later than anticipated”.
Although the headline rate of inflation fell back to 8.7 per cent in figures published on 24 May, core inflation has accelerated, increasing fears that a wage-price spiral has set in. Robert Wood, UK economist at Bank of America, said Britain now had the most "severe, persistent inflation problem among developed market economies”.
The central bank issued more optimistic growth forecasts in its May meeting, which suggested the UK would dodge a recession this year before returning to growth in 2024. But it was caught off guard by the higher than expected price growth (the 8.7 per cent figure compared with City forecasts of 8.2 per cent and BoE predictions of 8.4 per cent). Governor Andrew Bailey has conceded the central bank's forecasting model is not delivering accurate results.
According to Wood, the BoE's positive economic growth forecast was not consistent with getting inflation down to its 2 per cent target. He added: "This is fundamentally why we think the BoE will have to squeeze the economy more."
Investors and economists now expect interest rates to rise further this summer. Market expectations jumped after inflation figures were released, implying a peak rate of around 5.5 per cent.
Bank of America’s Wood added that “growth has to be weaker” as a result, and said the BoE would need to “drive demand down further than would otherwise be necessary to correct inflation expectations”.
Whether this will be enough to tip the economy into a true recession is unclear. Bank of America expects policymakers to keep the economy "close to recession”, and have revised their forecasts for 2024 GDP growth from 0.9 per cent to zero.
Not all economists agree that such drastic policy action will be necessary. Suren Thiru, economics director at the Institute of Chartered Accountants, said that “the drag on customer demand from a cooling jobs market, higher taxes and the lagged impact of rising interest rates may mean that inflation falls more quickly than the BoE has forecast”.
He added that if the BoE continues to raise rates, they risk “overtightening” and thereby worsening the cost of living crisis and the squeeze on businesses.
