Bank of England Warns of Record Slump in Standard of Living, As It Hikes Interest Rates for Second Time in Two Months

The BoE’s decision to implement back-to-back rate hikes, for the first time since 2004, heaps yet more pressure on stretched household finances and struggling businesses.

The Bank of England yesterday (Thursday, Feb 3) raised interest rates for the UK economy from 0.25% to 0.5%, its highest level since the early days of the virus crisis, after already raising them 15 basis points in December. The BOE also voted to begin quantitative tightening (QT) by paring back its holdings of government bonds. This it will do by allowing maturing government bonds to expire without replacing them, and by selling its corporate bonds outright.

Following its decision to hike rates, the BoE warned of a record slump in living standards, although obviously some people (i.e., those in the lower and middle classes whose finances are already stretched to the limit) will be more affected than others (e.g. the super rich, who have so far done exceedingly well out of the virus crisis).

The decision by the bank’s Monetary Policy Committee to hike rates was passed by a majority of five to four. Interestingly, the minority wanted an even larger increase to 0.75%, underscoring the Monetary Policy Committee’s increasingly hawkish stance. It was the UK’s first back-to-back interest rate hike since 2004.

Asked why the BoE is heaping yet more pressure on struggling households, the bank’s governor, Andrew Bailey, said:  “If we don’t take this action it will be even worse. It’s a hard message. I know it’s a hard message.”

The BoE forecast that inflation could rise as high as 7.5% by April. It is currently at 5.4%, its highest level in 30 years. The huge monetary stimulus programs unleashed by the world’s largest central banks in the first months of the virus crisis and maintained for over a year and a half, are almost certainly exacerbating global price rises, especially as this huge expansion of money supply has coincided with a sharply limited supply of vital products.

However, as Yves pointed out a couple of days ago in her preamble to the cross-post “Inflation Paranoia Threatens Recovery“, the effects of the rate hikes on inflation are likely to be muted given that many of the factors driving inflation are far beyond the scope of central bank control. Those factors include high energy and commodity prices; extreme weather events that have led to poor harvests; and Covid-short-staffing-related supply chain issues. Those issues are now being exacerbated by the vaccine mandates being imposed by some governments on key logistics workers such as truckers and port workers.

The central banks of large emerging market economies such as Brazil and Mexico have already tried to bring inflation under control through successive interest rate hikes. All they have achieved so far is to bring an abrupt end to their respective economies’ lackluster post-lockdown recovery. Both are now in technical recession. Meanwhile, the latest data (from December in the case of Brazil and January in the case of Mexico) show that inflation in each country remains little changed, clocking in respectively at 10.06% (down from 10.74% in November) and 7.36% in Mexico (down from 7.37% in December).

The interest rate hikes are squeezing yet more life out of the economy by making it even harder for heavily indebted businesses and consumers to service their debts. The result could be a stagflationary spiral, as already appears to be happening in Brazil. As Bloomberg reported in December, the dreaded combo of surging prices and stagnating economic activity is hitting the poorest Brazilians the hardest.

But emerging market central banks have less choice in the matter of whether or not to hike rates than their advanced economy counterparts. Besides trying to bring inflation under control, central banks in these countries also have to defend their currencies against a strengthening dollar, as I noted in my December 10 article, “Inflation Continues to Soar in Latin America, Even As Central Banks Intensify Their Rate Hikes“:

They know that if financial conditions in the U.S. and other advanced economies were to suddenly tighten, as the Fed and other major central banks begin hiking rates to stifle inflation (which isn’t beyond the realms of possibility), it could spark sharp asset sell offs and capital outflows in their own economies. And that is how many financial crises in Latin American have begun.

Back in the UK, markets now expect the BoE to raise interest rates to at least 1% by May, and 1.5% by November — a level that was not expected to be reached until March 2023 prior to Thursday’s announcement. Rising borrowing costs are likely to cause crippling economic pain for struggling consumers and businesses, especially with inflation already at a 30-year high of 5.4% and expected to continue to rise, at least in the short to medium term.

Rising prices of many essential goods and services are already biting hard into general living standards. Data published by the Office for National Statistics (ONS) on January 18 showed that average earnings climbed 3.5% year over year in November, 0.9 percentage points below the rate of increase for consumer prices. It was the first registered fall in real incomes since July 2020. Conditions are set to get even worse in April when increases in utility bills and taxes kick in.

It is against this backdrop that the BoE has decided to hike rates, as the FT reports:

The rise in official interest rates, alongside the highest rate of inflation for more than 30 years, would squeeze disposable household incomes by 2 per cent this year, with a further 0.5 per cent hit in 2023. That would be the biggest annual reduction in spending power since at least 1990, said BoE officials.

This would depress spending and reduce the UK growth rate to a crawl of about 1 per cent a year. However, the pain for households would help bring inflation down towards the bank’s 2 per cent target within two years, the MPC said.

The pain will not just be limited to heavily indebted households, which are once again ramping up their credit card debt. Many of the small and medium sized businesses that had to take on huge amounts of debt, in many cases for the first time ever, just to weather the lockdowns of 2020 will also feel the pinch (or in this case, the punch).

In October 2021, the Bank of England reported that a third of the UK’s small businesses are classed as highly indebted, more than double since before the Covid-19 pandemic. Thirty-three percent of SMEs saw their debt levels rise to more than 10 times their cash balances, compared to 14% before the pandemic. The proportion of those with high debt relative to both cash balances and monthly inflows surged to 10% from 3% during the same period.

“Although debt appears affordable in the near term, insolvencies are likely to rise from 2021 Q4 as government support is withdrawn as planned,” the BoE’s Financial Policy Committee said, adding that rising arrears did not represent a “significant risk” to the UK’s banking sector.

The main reason for this is that most of the risk has been borne by public finances. The UK government has guaranteed 100% of the funds disbursed by banks as part of the Bounce Back Loan Scheme (BBLS), which was aimed at SMEs, micro businesses and other businesses requiring small loans of between £2,000 and £50,000. It has also underwritten 80% of the funds disbursed by banks in the other three emergency business loan programs, the Coronavirus business interruption loan scheme (CBILS), the Coronavirus larger business interruption loan scheme (CLBILS) and the Recovery Loan Scheme.

In total, the Government has provided over £200 billion of emergency loans, guarantees and insurance cover to private sector firms since the pandemic began. In other words, as a UK parliamentary report warned in December, “if borrowers default, there will be a direct cost to the Government.”


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  1. thoughtful person

    Central bankers raise rates, end QE or even start QT (tightening) in the hope of ending inflation.

    Will today’s inflation be affected by these measures? It is true that much of current inflation is due to crazy commodity prices, and a spike in transportation cost (I suspect truck more than sea – recall getting to and from destination on either end of a sea move involves trucks).

    Why won’t a recession – or depression – affect demand for all goods and services?

  2. Don'tCallMeShirley

    This rather dim British socialist has a thought on interest rates: they are a means for capitalist regimes to subsidise the private housing system on which their re-election often depends. These regimes detest the very notion of what we Brits call council housing, which is why every Tory government since Thatcher in 1979 has been using every possible method to eliminate them and replace them with privately-owned individual homes as a financial asset which ties voters to the capitalist system and makes them fear and hate socialism.

    My understanding is that social housing is superior in providing places for people to live, with Vienna being one good example. However, middle-class people, who include most of the Left and pretty much every Green, are deeply integrated in the private housing economy which they feel at an atavistic level is their right not their privilege and that such inherited wealth in the form of property for them and their children is not to be touched. Many of these leftists are also landlords, one of the last vestiges of feudalism.

    Therefore, a rise in interest rates means mortgages become less affordable. Therefore, it hurts people who claim to be socialists but are really capitalists when it comes to their property. It might even make them consider social housing in a more positive light. I like that. Should I not?

    1. praxis

      I think this will be the crux that could get the masters of the universe off their current inflation fetish. It depends though, if a political power can aptly divert the social unrest/angst of falling property markets at someone else it may have a winner via deflationary concentration of wealth and useful election gimmicks.

      Also given they control the narrative matrix has, maybe they don’t care (they own both parties). So evict the wannabe-be capitalists prolls and let them gnash their teeth at lazy already homeless.

      1. tegnost

        It’s simpler than that. Put the agency where it belongs. The control fraudsters at the top have fleeced all the “lazy already homeless” and have fattened their next goose using “affordable debt”, which is now being made unaffordable debt, and this new unaffordable debt is the mechanism by which the next quintile will be fleeced.

        ‘“Although debt appears affordable in the near term, insolvencies are likely to rise from 2021 Q4 as government support is withdrawn as planned,” the BoE’s Financial Policy Committee said, adding that rising arrears did not represent a “significant risk” to the UK’s banking sector.”

        but don’t worry, it’s no threat to the banking sector.

    2. Mikel

      Here in the USA I have a hard time buying the concern about the effects of a rising Fed rate on working people and consumption. They do NOTHING about usuary that goes on no matter what fantasy finance rates the Fed pulls out of their butts. All of these low interest rates never get that low for non-privileged.

      My mind also goes immediately to their real concern. It’s housing prices here too. They want the low interest rates to help them flip the over-priced homes.

      And the housing musical chairs is even more important to the economy because, unlike manufacturing, it can’t be exported to another country for cheap labor.

      1. Felix_47

        In the US it is rare to find natives in the construction trades. We import the cheap labor and push the cost of their families on the Federal Government. Once the construction trades were a well paid career for many Americans……no longer. I used to earn a good living in construction but that was a long time ago. The equivalent wage today for construction labor would be pushing 70 dollars per hour compared to the 1960s. You can hire Mexican framers for 15 per hour all day. They often need training but they learn fast. Experienced ones might run you 20 per hour with no benefits. If you need more help they call their villages and recruit more workers who can get here in about ten days, max. And you hire them through the labor contractors to insulate the project from worker’s comp and legal issues. There is no requirement to verify their identity or tax status. And because labor is so cheap residential construction is a lot better than it was forty or fifty years ago.

  3. The Rev Kev

    One almost suspects that with so many small businesses about to go broke, that there are a lot of cashed up corporation waiting in the wings to swoop in and grab up their assets and properties at bargain-basement prices.

  4. eg

    So how is paying already rich bond holders even more money supposed to reduce inflation? It’s all BS.

    Oh, meanwhile that prat Bailey wags his fingers at workers not to ask for wage increases while he hands the already rich bond holders even more money. When can we expect him to browbeat oligopolistic and monopolistic firms not to raise their profit margins? Yeah, right — pull the other one …

  5. Sound of the Suburbs

    How have the neoliberals made a rising cost of living such a big problem?

    Theresa May’s JAMs (Just about Managing)
    It’s not going to take much to push them over the edge.
    She never did work out the nature of the neoliberal squeeze.

    “Are you sure housing costs are part of the cost of living?” neoliberal policymakers
    They do tend to ignore them.

    Back to the real world.
    Rising housing costs will tend to push up wages and squeeze consumers.

    What can the neoliberals do about the inflation stats.?
    They come up with a measure that under represents housing costs so they don’t show up too much, e.g. CPI.

    The poor old neoliberals then find themselves getting caught out.

    How have the neoliberals left so many on the edge?
    The neoliberal squeeze.
    Disposable income = wages – (taxes + the cost of living)
    They keep wages down, and let the cost of living soar through high housing costs.
    These are Theresa May’s JAM’s (Just about managing)

    The French were already on the edge due to the neoliberal squeeze.
    Macron then raised fuel taxes.
    This was the last straw that broke the camel’s back.
    They put on their yellow vests and took to the streets,

    The cost of living doesn’t have to rise much before many are in real trouble.

  6. DTK

    The headline could have read “Bank of England Warns of Record Slump in Standard of Living, As It Hikes Interest Rates for Second Time in Two Months To Increase Increase Inflation and Inflict Austerity.”

  7. Reaville

    Read that “the elites” are pulling money from the stock market which has no room to go higher. Their preferred new home for their cash is hard assets, especially real estate where they can earn rental income and wait for capital gains. This slosh of money into the housing market has juiced prices. What would lower these prices is a hike in interest rates.

    So here’s the plan: cashed out of stock market bubble but created a real estate bubble, fix the RE bubble by hiking rates, housing prices fall sharply this year, and now your stock market winnings can buy cheap in a depressed housing market.

    Also, a few years from now when financial assets have declined and are high yielding, stock and bond markets will be investable again. In the present day, Goldman/Morgan/et al are building short trades to make money on the way down.

    Free markets are so much fun!

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