Stagnation warning as incoming BoE chief brands Britain’s economy ‘weak’

World News

Britain could be on the brink of an economic slowdown in the coming years with the “full effects” of interest rate rises yet to be felt, the incoming deputy governor of the Bank of England has warned.

Sarah Breeden, who will replace Sir Jon Cunliffe as the Bank’s deputy for financial stability in November, highlighted that while the rising Base Rate has been necessary to help bring down inflation, the impact it’s had pushing down on demand – paired with weaker supply – could result in a stagnant economy.

In a questionnaire published on Tuesday, Ms Breeden said: “The MPC has responded to inflation pressures by raising Bank Rate by more than 500 basis points since December 2021. Whilst much of the impact of the rise in Bank Rate is to come, this monetary policy action has already materially pushed down on inflation.

“A simple rule of thumb would suggest that inflation could have been around three to five percentage points higher had the MPC not increased Bank Rate.”

However, she noted: “I would expect relatively flat GDP in the UK over the next couple of years, as the impact of past increases in the Bank rate increasingly pushes down on demand, and supply remains very weak.”

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The UK’s Consumer Price Index (CPI) inflation rate dropped to 6.8 percent in July 2023, and Ms Breeden predicts it “should decline over the rest of the year” to around five percent.

She explained: “Much of the decline will be driven by energy prices, which are no longer rising at the high rates we have seen for the past couple of years and have begun to fall.”

Food and core goods inflation should also fall, however, she noted: “Over the next two years, demand should weaken and push the economy into excess supply, which will push down on inflation further via domestic channels.

“I expect inflation to be around the two percent target in two years, conditional on the assumptions in the August forecast.”

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In an effort to protect falling real incomes amid a period of record-high inflation, workers, managers and business owners have sought compensation in the form of higher nominal pay and domestic selling prices.

But this has increased domestic price and wage inflation and so made inflation “more persistent”, Ms Breeden noted.

She said that the UK’s economy is “weak in absolute terms”, with gross domestic product (GDP) just a little ahead of where it had been before the pandemic, despite a recent upgrade in the official statistics.

But she added that if they wanted to totally offset rising inflation, the MPC members would have had to increase rates twice as fast as they had, which could have sent shockwaves through the economy.

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Ms Breeden said: “Had the MPC sought to offset entirely the overshoot of inflation above target over the past couple of years, they would have had to do two things. First, they would have had to foresee the effects of the recovery from COVID-19 on import prices and excess demand, as well as the impact on inflation from the invasion of Ukraine, well in advance of them happening.

“Second, they would have had to increase interest rates to more than double their current level. This would have led to a deep (global financial crisis-sized) recession, a huge increase in unemployment and a fall in nominal wages just as the economy was recovering from COVID-19. Neither of these seem like plausible counterfactuals.”

The Monetary Policy Committee will next meet to discuss the Base Rate on September 21, 2023.

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