The word “bleak” comes to mind when I think about the Bank of England’s most recent economic projections for the nation for the next two years. But do we anticipate a recession?
In the face of rising prices and a reduction in economic activity, the central bank is predicting one of the longest recessions ever (thanks in part to higher interest rates, which it controls).
Policymakers reviewed their prognosis for the economy and the two scenarios they think are most likely to occur over the next couple of years during the news conference that followed the central bank’s statement on interest rates yesterday.
The Bank of England’s governor, Andrew Bailey, was given the unpleasant task of describing why forecasters are so pessimistic.
He noted that there are “significant distinctions between what the UK and Europe were confronting in terms of shocks and what the US is experiencing,” pointing out that the economic picture in Europe and the UK is mostly uncertain due to the rise in energy costs.
Inflation is a challenge for the Bank of England.
The majority of the problems that European countries are currently facing can be attributed to high energy prices.
Europe heavily depends on imports to meet its energy demands, in contrast to the US, which produced more oil and natural gas than it consumed in 2019.
Even the UK, which has large oil and gas deposits in the North Sea, only generates around half of its own needs; the majority of the rest is imported from Norway.
Due to Russia’s decision to stop supplying the area, purchasers are now forced to bid on gas on the open market, where prices are significantly higher than those under supply contracts from previous years.
Additionally, dollars are used in the trading of oil and gas on international markets. Over the past year, the value of the pound and the euro against the dollar has decreased by 16% and 14%, respectively. That simply serves to stoke the fire.
Each sector of the economy is impacted by higher energy expenditures. A bar owner must raise pricing for customers if heating costs are expected to increase by 100%.
Customers will either strive to earn more money or make other cuts if they have to pay more. If they succeed in earning more, they will be able to spend more, which will increase prices.
And the Bank of England is currently dealing with this problem. Both prices and incomes are rising. Although overall salaries are still declining in real terms, certain workers—especially those who are unionized—are achieving double-digit pay gains.
Increased interest rates are intended to curb inflation.
To combat inflation, the Bank of England is raising interest rates.
Theoretically, as rates rise, consumers will save money rather than spend it, putting more pressure on firms to compete for customers’ remaining disposable income. This can result in reduced costs (conversely, if the bank wants to stimulate demand, it can reduce interest rates, making borrowing more affordable and spending less attractive).
According to predictions made by the Bank of England, inflation will return to 0% by 2025 if interest rates continue to rise and peak at 5.25% next year.
But this will have a significant effect on economic activity. With eight quarters of economic contraction, the economy could experience the longest recession since the Second World War (the economy is officially in recession if it shrinks for two quarters a row). In this case, the unemployment rate might also increase to 6.4%.
One projection is that.
A more upbeat prediction was also made by the Bank of England, which said that if interest rates remained at their current level of 3%, inflation would decline to 2.2% in two years and unemployment would grow, but only to 5.1%.
Even though the economy would still shrink, it would do it more moderately than in the past.
When asked which scenario he believed was most likely to occur during the following years, Andrew Bailey responded, We’re not providing advice on where the truth lies between the two, he said.
The issue with unknowable unknowns at the Bank of England
The section of the news conference that Bailey made that was arguably the most accurate was her statement.
Due to the uncertainty surrounding the economy, both of the major predictions made by the Bank of England are nearly certainly off.
Only interest rates, which are a blunt instrument, can be effectively managed by the central bank. Energy prices, which are currently the main cause of inflation, are beyond its control.
Additionally, it has little influence over the government’s spending and taxation policies, which will be revealed in the budget on November 17th.
And this is where things really start to get tricky.
The government’s decision to try to close its £50 billion budget gap by decreasing spending and, as a result, reducing economic activity, will have an effect on inflation and the trajectory of the economy.
The Energy Price Guarantee, a tenet of Liz Truss’ previous administration, also requires clarification. The guarantee will cease in the first quarter of 2023, and Jeremy Hunt, the new chancellor, has vowed that a “more tailored” support program will take its place.
Depending on how this support program is set up, it can have a favorable or unfavorable effect on predictions of inflation and, consequently, the Bank of England’s interest rate choices.
What do the estimates from the Bank of England mean for your finances?
Right now, uncertainty reigns supreme, making it exceedingly impossible to predict what the future contains for investors and savers.
The governor did, however, provide some advice for potential borrowers, stating that “rates on new fixed rate mortgages do not need to climb as substantially as they have done recently.”
This is due to the fact that while interest rates are likely to rise from here, they are not likely to reach the levels that the market had previously predicted following the terrible mini budget at the end of September.
Higher interest rates are advantageous for savers as well, so if you haven’t lately looked about for a better deal on your money, this is the time to do so.
The Bank of England’s more positive prediction, which suggests that rates might not rise much higher than 3%, suggests that now might be a good time to start thinking about mending your investments.
Uncertainty is the current watchword for investors. In this scenario, investors should prioritize capital protection before chasing gain.
Cash is beginning to appear to be the more appealing alternative as savings account interest rates get closer to 5%.