UK in recession and further interest rate hikes on their way, Bank warns Kwarteng

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The Bank of England has warned Kwasi Kwarteng the economy is in recession and it will most probably need to push interest rates higher following Friday’s tax-cutting mini budget from the chancellor.

On the eve of a major package of support from the chancellor designed to break what he called the economy’s “cycle of stagnation”, Threadneedle Street said the UK economy was heading for a second consecutive quarter of falling output, with gross domestic product set to shrink 0.1% in the three months to September.

However, with energy and food bills still soaring, and inflation not expected to peak until October, the Bank of England raised the cost of borrowing for a seventh successive meeting of its monetary policy committee (MPC) and made clear the new government’s plans risked triggering more interest rate hikes.

The MPC – which put up interest rates by 0.5 percentage points to 2.25% on Thursday – said it would be carefully assessing the impact of the government’s energy price caps and growth plan ahead of the committee’s next decision in November.

In a letter to the chancellor explaining why inflation is running at almost five times its 2% target, the Bank’s governor, Andrew Bailey, said: “Should the outlook suggest more persistent inflationary pressures, including from stronger demand, the committee will respond forcefully, as necessary.”

Kwarteng will on Friday announce 30 separate measures – including tax cuts, new investment zones and an acceleration of infrastructure projects – in an effort to raise the economy’s growth rate to his stated target of 2.5% a year.

One of the main elements of the package – the ?13bn reversal of the increase in national insurance contributions, introduced in April to fund the health and social care levy – will come into force on 6 November, three days after the Bank’s next interest-rate decision.

While almost 28 million people will keep more of their earnings as a result of the move, the Resolution Foundation thinktank said on average the poorest 10% of households would gain ?11.41 in 2022-23, while the richest 10% of households would gain ?682.

The mini-budget is expected to contain significant further interventions to boost growth beyond the reversal of the NICs rise and next April’s planned increase in corporation tax, Treasury sources have confirmed, with one Whitehall source describing the package as having “more rabbits than Watership Down”.

One key plank of the fiscal event will be new investment zones for 38 local and mayoral authorities in England – including West Midlands, Tees Valley, Somerset and Hull – which will have major planning deregulation to release more land for housing and commercial development, and tax cuts for businesses.

The investment zone plans include a number of controversial measures such as removing the need for developers to meet affordable housing targets, as first revealed by the GuardianEnvironmental regulation will also be slashed in these zones.

Kwarteng will defend plans to lift the cap on bankers bonuses and the ban on fracking, saying the government will be “bold and unashamed in pursuing growth – even where that means taking difficult decisions”.

He will also announce measures to accelerate the delivery of about 100 major infrastructure projects across the country that he will say have been unnecessarily delayed by bureaucracy.

The chancellor will tell MPs: “Growth is not as high as it needs to be, which has made it harder to pay for public services, requiring taxes to rise. This cycle of stagnation has led to the tax burden being forecast to reach the highest levels since the late 1940s.

“We are determined to break that cycle. We need a new approach for a new era focused on growth. That is how we will deliver higher wages, greater opportunities and sufficient revenue to fund our public services, now and into the future.

“That is how we will compete successfully with dynamic economies around the world. That is how we will turn the vicious cycle of stagnation into a virtuous cycle of growth.”

Pat McFadden, the shadow chief secretary to the Treasury, said the sums involved were extraordinary without any examination of how they would be funded, other than through borrowing.

“Their choice to fund all of this through borrowing and not attempt to fund even a proportion of it through a windfall tax on the energy companies making the most from the current crisis increases risk and leaves British taxpayers paying more for longer,” he said.

Announcing its latest interest-rate decision, the Bank of England said the energy price guarantee, which caps bills for households, would mean inflation would peak at just below 11% this autumn rather than exceed 13%. Although the consumer prices index eased slightly from 10.1% in July, reaching 9.9% in August, it remains at a level not seen since the early 1980s.

However, Bailey said in his letter to Kwarteng the government’s support measures risked adding to upward pressure on the cost of living. “All else equal … this will add to inflationary pressures in the medium term,” Bailey wrote.

After a 0.1% drop in GDP in the three months to June, the Bank said a further 0.1% decline could now be expected in the third quarter amid a slump in consumer spending and weaker activity for manufacturing and construction.

It said the fall also reflected a smaller-than-expected bounce back from the additional bank holiday for the Queen’s platinum jubilee, as well as the impact from businesses closing their doors in a mark of respect for the state funeral this week. An economy is technically in recession if it suffers two successive quarters of negative growth.

Susannah Streeter, a senior investment and markets analyst at Hargreaves Lansdown: ”The starting whistle has been blown on the economic tug of war between the Bank of England and Liz Truss’ government.

“Team Bailey at the Bank of England want to squeeze demand out of the economy, to try and stop the spiral of prices, while Team Truss want to stimulate it, risking prolonging the pace of rate hikes.”