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BOE set to tip UK into recession by year end, economists say

Simon Osuji by Simon Osuji
June 27, 2023
in Finance
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BOE set to tip UK into recession by year end, economists say
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The Bank of England will push the UK into recession by the end of the year in its battle to curb the worst inflation of any Group of Seven economy.

That’s the warning from Bloomberg Economics, which says a shallow if protracted downturn is the price of taming an inflation rate that remains stubbornly close to double digits — despite 13 straight interest-rate increases since the end of 2021.

Economists Dan Hanson and Ana Andrade now expect a yearlong recession starting in the fourth quarter to cost just over 1% of economic output. That assumes the BOE raises rates to 5.75% by November from the current 5%. However, money markets are almost fully pricing in 6.25% by December, raising the possibility of a far worse slump.

“The risk is the data continue to prove unresponsive to the BOE’s actions and interest rates rise further than our baseline,” Hanson and Andrade wrote. “As borrowing costs move above 5%, we think the risk of a financial stability shock increases exponentially.”

The analysis means Prime Minister Rishi Sunak could be fighting the next election against a backdrop of shrinking output, rising unemployment and mounting home repossessions as mortgages costs continue to climb. The average 2-year home loan is now around 6.25%, approaching the levels seen during the market turmoil that brought down his predecessor, Liz Truss, last autumn.

While Sunak doesn’t have to call an until January 2025, he is widely expected to go to the polls next year. Surveys show his Conservative Party consistently trailing the Labour opposition by more than 10 percentage points.

Causing the economy to shrink would also heap criticism on the BOE, not least from Conservative lawmakers at risk of losing their seats. The BOE now faces the very real possibility of having to reinstate its recession call at its next forecasting round in August, just three months after delivering the biggest upgrade to its projections since gaining independence in 1997.

Hanson and Andrade expect the economy to grow just 0.1% this year and shrink 1% in 2024, a sharp revision from the 0.3% growth previously estimated.

Even then, with wage growth refusing to subside and cheaper energy set to boost household incomes, inflation will end this year just above 5% — more than double the 2% target and down only modestly from the current 8.7%. In an illustration of strength of underlying cost pressures, core inflation — which hit a 31-year high of 7.1% in May, — is only likely to move below 6% in early 2024.

“The recent strength of the inflation and wage data has left the BOE with little choice but to squeeze the economy even harder,” Hanson and Andrade write. The BOE will start cutting rates in the second quarter of next year but proceed cautiously, given that inflation will still be above target.

“The big risk to our forecast is that the BOE tightens by more than we have assume,” they said. “In a world where it followed market expectations, which is about 100 bps higher on average over the next three years compared to our forecast, we would expect the economy to be about 1% smaller by 4Q25 with a deeper recession.

“What that estimate could easily miss is the possibility that the lags from past tightening are longer than we have assumed or that high rates create financial instability. Should either of those scenarios play out, the recession would be significantly deeper.”

© 2023 Bloomberg



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