The Bank of England gave two pictures on the outlook for the UK economy on Thursday. Both scenarios were bleak. Whatever happened, the central bank said, Britain’s economy was sliding into a recession that would last at least all of next year. Unlike the US Federal Reserve, which on Wednesday remained hopeful of a “soft landing” for the US economy, the BoE’s talk was of falling Gross Domestic Product and a “very challenging” outlook. Andrew Bailey, governor of the BoE, said this was inevitable because there were “significant differences between what the UK and Europe were experiencing in terms of shocks and what the US was experiencing”. Europe, unlike the US, is grappling with rising gas prices following Russia’s invasion of Ukraine. The gloomy forecasts of the Bank did not end with a recession. Inflation will remain above 10 percent for the next six months and above 5 percent for all of 2023. Unemployment, currently at a 50-year low of 3.5 percent, will end next year over 4 percent. If all this pain was common to both BoE scenarios, the differences between them were central to the central bank’s messages. In the BoE’s first scenario – usually seen as its main forecast – forecasts were based on the assumption that financial market expectations of future interest rates would mean they would peak at 5.25 per cent next year. If interest rates were to rise above this level, the BoE’s Monetary Policy Committee thought the UK would likely have to endure eight quarters of economic contraction: the longest recession since the second world war. Unemployment will rise to 6.4%. This financial pain would weigh on inflation, driving it to zero by the end of 2025. But with the BoE targeting 2% inflation, Bailey was clear that this scenario suggested markets were at risk of getting their bets on future monetary policy wrong. “We think [the] Bank rate should rise by less than what is currently priced in the financial markets,” said Bailey. The BoE’s alternative scenario – which is usually buried in the central bank’s forecast documents – that interest rates remain steady at the current level of 3 percent was given much greater emphasis in the presentations by Bailey and his team. Under this forecast, output would still shrink, but only by half of the first scenario, resulting in a mild recession by historical standards. Inflation would ease to 2.2% in two years, before falling below the BoE’s target. Unemployment will rise, but only to 5.1%. Many economists said the BoE’s alternative scenario was a clear signal from the central bank that it was close to being done with rate hikes, having now raised them from 0.1 percent a year ago to 3 percent, the highest level since 2008. Kallum Pickering, an economist at Berenberg, said the slowdown in the BoE’s first scenario meant the central bank “may need to do much, much less than the market expects in terms of further rate hikes to bring inflation back to its 2 %. Asked which of the two BoE scenarios he thought was more likely to happen, Bailey said he would not be drawn. He did not want to commit himself to a particular view on future rates, saying: “Where the truth is in between, we don’t give guidance on that.” The main reason for declining to be more specific is the possibility that inflation may turn out to be more entrenched than the Bank currently believes. Bailey said that while no forecast would ever be exactly right, the main risk was that inflation would still be higher than central forecasts under both BoE scenarios. A key risk for the BoE is that wage growth could easily remain higher than it would like, with companies feeling able to raise prices without losing too much business. Ruth Gregory, economist at Capital Economics, said the BoE’s several upward revisions to market expectations of future interest rates over the past year suggested inflation could prove “stickier” than expected. he hoped By the end of the day, markets had taken little notice of the BoE’s dovish scenario. Ahead of the midday BoE announcement, markets priced in interest rates peaking at 4.75 percent next year. By the end of the day, they were betting they would top 4.72% next September. Market expectations for future monetary policy will move and Bailey was keen to highlight what would guide the BoE’s decisions in the coming weeks. Most important, he said, will be the evolution of economic data, particularly on wages and business pricing strategies. If these soften, the BoE would feel less need to raise rates further. The path of wholesale energy prices would also be critical and the BoE will hope that these moderate further, having more than halved since late August. The other crucial factor will be Chancellor Jeremy Hunt’s autumn statement on 17 November. If the government proceeds with immediate public spending cuts and tax increases to plug a gap in public finances, it will further squeeze the economy and reduce pressure on the BoE to raise interest rates. Ben Broadbent, the BoE’s deputy governor, suggested that any fiscal action by the government would need to be “relatively short-term” to influence the central bank’s interest rate decisions.
