A “tough road” lies ahead for Britain, the governor of the Bank of England said on Thursday, as the central bank warned the country faces its longest recession since records began.
Andrew Bailey said a sharp increase in energy prices as a result of Russia's war on Ukraine had significantly affected the economy, making the country poorer.
But he said it will recover, and inflation is predicted to fall, “probably quite sharply” from the middle of next year.
He was speaking shortly after the bank unveiled its biggest rise in interest rates in more than three decades on Thursday, aiming to tame soaring levels of inflation.
The bank's Monetary Policy Committee (MPC) rose the base rate by 0.75 percentage points to 3 per cent.
That represents the eighth consecutive jump in interest rates by the central bank, and the biggest increase since 1989.
The increase will pile about £3,000 ($3,442) per year on to mortgage bills for those households that are set to renew their mortgages, the bank said.
The pound slipped and the cost of government borrowing rose in response to the rate hike and warning of the longest recession on record.
The pound was 1.89 per cent lower against the greenback at $1.1166, at 1.37pm local time.
“The sharp increase in energy prices, caused by Russia's invasion of Ukraine, has made us poorer as a nation,” said Mr Bailey.
“The level of economic activity in our economy is likely to be flat, and even fall, for some time.
“But the economy will recover. And inflation will fall.
“We cannot pretend to know what will happen to gas prices. That depends on the war in Ukraine. But from where we stand now, we think inflation will begin to fall back from the middle of next year, probably quite sharply.
“To make sure that happens, the bank rate may have to go up further over the coming months.”
Mr Bailey said he understood the difficulties people faced, and the rate rise represents “big changes and they have a real impact on people's lives”.
He warned of a tough road ahead. But he said if the country does not act “forcefully now, it would be worse later on.”
Inflation is currently running at 10.1 per cent, but the bank predicted a peak inflation rate of just under 11 per cent. If the bank does not act to tame it, inflation will worsen, Mr Bailey said.
“This is a difficult time,” he said. “There is no easy outcome”.
Mr Bailey said the peak in expected rates would probably be “lower than priced into financial markets”.
And that was important, because it means that “fixed rate mortgages should not need to rise as much as they have done,” he said.
However, the bank said the UK could be on course for the longest recession since reliable records began in the 1920s, as the economy faces a “very challenging outlook”.
Gross domestic product (GDP) could shrink for every quarter for the next two years, with growth only returning in the middle of 2024.
Experts have said the Bank of England will be left with few “easy choices” as the UK economy deteriorates.
Yael Selfin, chief economist at KPMG UK, said another potential rise in the cost of living could come in April, when the government's Energy Price Guarantee scheme ends.
That may mean raise interest rates will need to rise even more quickly, she said.
“At the same time, the outlook is riddled by the evolution of energy prices, while the risk of a significant fall in house prices looms in the background.”