UK interest rates to hit 3% by spring as leading economist declares ‘worst day for British economy’

Professor Danny Blanchflower warned the Bank’s decision would be an ‘electoral disaster for the Government’ with Conservative leadership candidates ‘handed the poisoned chalice’.

A leading economist has declared “the worst day for the British economy in my lifetime” after interest rates were hiked again.

It came as experts predicted a rise to 3 per cent by spring next year.

Professor Danny Blanchflower said the Bank of England’s argument for raising interest rates to combat soaring inflation, at the same time as predicting a recession for the country, was “nil”.

Professor Blanchflower, who sat on the Bank’s Monetary Policy Committee (MPC) as an external member from 2006 to 2009, said the committee’s actions were driven by “political pressure, incompetence and group think”.

Were he still an MPC member, Prof Blanchflower said he would have voted for an interest rates cut today.

On Thursday interest rates were hiked to 1.75 per cent from 1.25 per cent – the highest level since January 2009 and the biggest single increase since 1995. The Bank of England also said the UK is set to fall into a five-quarter recession from the fourth quarter of 2023 – prompted by rising energy prices – but that it will be shallower than the 2008 crash.

However Professor Blanchflower suggested the UK could be headed for more economic turbulence than during the Great Recession.

He warned the Bank’s decision would be an “electoral disaster for the Government” because Conservative leadership candidates Liz Truss and Rishi Sunak “are going to be handed the poisoned chalice”.

He told i: “If you call an election, there is going to be an unemployment rate in double digits, firms closing, houses in foreclosure – this is going to be a disaster. [The MPC hasn’t] understood controlling inflation is not the big deal, inflation is going to disappear… The worry is they’re going to have deflation – that’s what the forecast says. I’m completely astonished.”

Despite concern about the effectiveness of using interest rates to bring down inflation, economists expect the Bank of England to go much further.

Some say interest rates could hit 4 per cent in 2023, but the consensus appears to be in the region of 3 per cent.

Stephen Millard, deputy directory of the National Institute of Economic and Social Research, told i: “We’re expecting interest rates to rise to three per cent.

“However if inflation goes higher and/or looks like it is becoming more persistent, then we would expect interest rates to rise even higher. How high would depend on how high inflation went and what was driving the higher inflation.

He added: “If the higher inflation were expected to be more persistent then interest rates would rise by more than if the higher inflation were expected to be temporary.”

Professor Charles Goodhart, who served on the MPC as an independent member from 1997 to 2000, also warned that “no one knows quite how high” the committee will take interest rates to roll back inflation.

The Bank itself said it “will take the actions necessary to bring inflation down” but that interest rates will not reach “the very high levels” some people have witnessed in the past. They hit 17 per cent rate from November 1979.

Why are interest rates increased to bring down inflation?

Increasing the cost of borrowing through interest rates deters people from spending and encourages them to save. This in turn means the price of goods tends to rise more slowly, lowering inflation.

Since December 2021, the Bank of England has continually increased interest rates because its target inflation rate for the UK is two per cent – way below the current figure of 9.4 per cent.

In a sign of what’s to come for interest rates, the Bank has warned inflation will peak at more than 13 per cent as energy prices are expected to soar further. However, the Bank of England expects inflation to drop below two per cent towards the end of 2023.

How high could the interest rate go?

The first thing to remember about the Bank’s interest rate is that there is no cap. However, the MPC will be aware of the impact of their decision for the public.

Economists are wary of raising interest rates too high because it could worsen the cost-of-living crisis for people by hiking mortgage, credit card and loan payments.

Financial markets generally expect the BoE to raise rates to three per cent in 2023, with a cut to 2.75 per cent around the end of the year.

Professor Costas Milas, from the Management School at the University of Liverpool, broadly agreed, saying there are good reasons for not going any higher.

The first, he said, is that the UK economy is slowing down. The second is that the Bank of England will need to take into account what the Federal Reserve announces for the US interest rates, which will have ramifications for advanced economies, including the UK.

The economics team at Schroders, a global asset and wealth manager, warned interest rates might need to rise to above five per cent to bring down inflation quickly. It added: “This is not our forecast, and we therefore expect inflation to remain above target for longer than ideal.”

Are interest rates the best tool to target inflation?

Dr Tony Syme, a senior economics lecturer at the University of Salford, described higher interest rates as an “inept tool” to tackle inflation.

The factors causing this period of inflation – post-Covid supply chain pressures, a declining UK labour force and the Russian invasion of Ukraine – cannot be addressed by an increase in interest rates, he argued.

“They are trying to carry water in a sieve. The intention may be reasonable, but the tools are wrong.”

He told i: “Andrew Bailey today repeated his Mansion House speech when he said ‘there are no ifs or buts in our commitment to the two per cent inflation target’. That means interest rates will exceed two per cent this year and are very likely to exceed four per cent next year.”

“Through no fault of their own, people are already paying the cost of this inflation with the cost-of-living squeeze. This new rise in interest rates means that people will again suffer the consequences.

“The answer lies in international diplomacy and an end to the war in Ukraine, not interest rate rises.”

Source: iNews