An interest rate rise by the Bank of England to 4% is a big call when households are suffering from a second cost of living crisis in four years. Many people will be incredulous when they hear of the decision to increase the cost of borrowing by 0.25 percentage points, looking around their neighbourhood for signs of a booming economy. The official figures show the economy has proved resilient in response to the jump in oil and gas prices after the outbreak of war in Iran, but UK high streets are struggling and the underlying drivers of inflation are absent.
Most households are spending to stand still, whether it is on food, energy, holidays or leisure pursuits. Businesses are in much the same position. Like households, they have absorbed significant tax rises.
What the Bank’s policymakers believe is that despite all this, the energy price shock, being larger than first estimated, will surge through all parts of the economy, forcing up prices, encouraging a wave of wage demands that will, in turn, give inflation a second burst of life next year and the following year. This analysis stands in contrast to the Office for Budget Responsibility (OBR), which acts as the Treasury’s independent forecaster. The OBR was clear in evidence to parliament on Wednesday that there was little impetus for strong wages growth.
The OBR said that, rather than economic growth next year of 1.6% and a rise in inflation to 4.9%, as the Bank expects, it believes the economy will expand by just 1% in 2027 and that the consumer prices index (CPI) will peak at just 3.75%. Inflation hit 3.5% in September, official figures showed. OBR chief economist, David Miles, said one of the main reasons for this assesment was the state of UK businesses, which he judged to be quite weak.
He said they had absorbed a large slice of the rise in energy and fuel costs, and their profit margins had plummeted on average as a result. Where once margins averaged 13% to 14%, the latest figures show they have fallen to 10% to 11%. He said there would be little appetite to pay high wage settlements and the imperative would be to rebuild margins.
The wider economic situation is also very different from the previous crisis in 2022, when the country was coming out of the pandemic and dealing with the onset of the Ukraine war. Back then, households were awash with lockdown savings that they wanted to spend, and firms were struggling to hire enough staff, leading to intense competition for workers and a spike in wages. Today, savings are low and households bear the scars of four years of high inflation.
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