UK Executes Big Step for First Time in 27 Years... "Concerns Over 15 Consecutive Months of Recession and Worst Inflation Overlap" (Summary)

Year-end inflation rate projected at 13%, worst in 60 years
Ruling conservative party promises large-scale tax cuts... concerns over policy confusion
Stagflation fears... "Could become a complex economic crisis"

[Image source=Yonhap News]

[Asia Economy Reporter Hyunwoo Lee] The United Kingdom, which implemented a ‘big step’ by raising the base interest rate by 0.5 percentage points for the first time in 27 years, is facing warnings that it will encounter a stagflation crisis characterized by a prolonged economic recession and severe inflation simultaneously starting from the second half of this year.

On the 4th (local time), the Bank of England (BOE), the UK’s central bank, announced at the Monetary Policy Committee (MPC) meeting held that day that it would raise the base interest rate from the existing 1.25% to 1.75%, an increase of 0.5 percentage points. With this, the BOE has raised interest rates six consecutive times since December last year. This rate hike was approved with eight out of nine MPC members in favor and one opposed.

This is the first time in about 27 years since February 1995 that the BOE has implemented a big step of raising the base interest rate by 0.5 percentage points or more. As a result, the UK’s base interest rate has risen to its highest level since December 2008 during the global financial crisis.

[Image source=Reuters Yonhap News]

In a statement released that day, the BOE said, "Since May, wholesale gas prices in the UK have more than doubled, and there is a continuing risk of price increases amid Russia’s pressure to limit gas supply," forecasting that the consumer price index (CPI) inflation rate will soar to 13.3% year-on-year by the end of the year.

The UK’s CPI inflation rate in June recorded 9.4%, the highest in 40 years, but the rapid price surge has yet to be controlled. If the year-end inflation rate rises above 13% as the BOE predicts, it is feared that the worst inflation in 60 years will occur.

In particular, the BOE is drawing more attention by implementing the big step despite recession forecasts. In the economic outlook announced along with the rate hike, the BOE predicted, "From the fourth quarter of this year, there will be a continuous recession for five consecutive quarters (15 months), and the gross domestic product (GDP) growth rate will fall by more than 2%." The BOE added that economic recovery is expected to begin from the end of 2024 but will proceed very weakly.

Andrew Bailey, Governor of the BOE, said in an interview with CNBC that "rising energy prices are leading to a decline in real income, and there are concerns about a recession from the latter half of this year," emphasizing, "We will continue to maintain monetary policy to bring inflation back to the existing target of 2%."

[Image source=Reuters Yonhap News]

However, the ruling Conservative Party in the UK is expected to cause policy confusion as it pledges large-scale tax cuts ahead of the next prime minister election. Liz Truss, the current Foreign Secretary and the leading candidate in the Conservative Party leadership election to select the next UK prime minister, has pledged a tax cut plan worth 30 billion pounds (about 47 trillion won). There are concerns that if large-scale tax cuts release more funds into the market, inflation will worsen.

On the contrary, Foreign Secretary Truss criticized the BOE’s response to inflation as very delayed. In a campaign speech held yesterday in Cardiff, UK, she said, "The best policy to deal with inflation is monetary policy. Faster and stronger monetary policy is needed to control inflation going forward, and we will consider changing the BOE’s authority for swift decision-making."

Experts warn that if rapid inflation, economic recession, and policy confusion overlap, the UK economy will face a serious stagflation situation. Luke Bartholomew, Chief Economist at Aberdeen (ABRDN), a UK investment firm, analyzed, "From the end of the year, as inflation and recession occur simultaneously, political pressure on the BOE will increase, making it difficult to continue the current rate hike policy steadily," adding, "There is a possibility of a much more severe complex economic crisis in the UK compared to other major countries."